Paying for health insurance and health care can put a significant dent in your wallet. To help families cope with rising medical costs, Health Savings Accounts (HSAs) were created by the federal government in 2003. These accounts can be used to save money, on a tax-free basis, for approved medical expenses.

How Health Savings Accounts work

HSAs can be set up either through an employer or independently. Contributions to the account, as well as any interest that accumulates, are tax-exempt up to a certain dollar amount.

In 2011, you can contribute up to $3,050 tax-free to an individual HSA. Tax-exempt contributions to family HSAs are limited to $6,150. In 2012, those amounts increase to $3,100 and $6,250, respectively.

Money from HSAs can be used to pay for approved medical expenses, including prescription drugs and some vision and hearing aid purchases. Some financial institutions offer HSA owners debit cards to make accessing funds in the accounts more convenient.

HSAs differ from flexible spending accounts

These accounts should not be confused with flexible spending accounts (FSAs), which also offer the opportunity to pay for medical expenses with tax-free dollars. With an HSA, you own the account and it is not tied to your job. FSAs, on the other hand, can only be established by employers.

In addition, the balance in an HSA rolls over from year-to-year, allowing you to save a larger amount for future medical needs. Money in a FSA must be used by the end of the calendar year (some employers allow workers a two and a half month grace period at the end of each year) or the funds are returned to the employer.

Who can open a Health Savings Account?

To qualify for an HSA, you must meet certain eligibility guidelines:

  • You must be enrolled in an eligible high-deductible health insurance policy.
  • You must not be covered by Medicare or have medical coverage other than the high-deductible plan.
  • You cannot be claimed as a dependent on someone else's tax return.

Eligible high-deductible health insurance must have a minimum deductible of $1,200 for individuals and $2,400 for families, according to IRS regulations. The high-deductible plan also must cap out-of-pocket costs for deductibles and in-network care at $5,950 for individuals and $11,900 for families.