A Health Savings Account is a trust account into which tax-deductible contributions can be made by qualified taxpayers who have high deductible medical insurance plans. Income earned on the HSA balance is tax-free. The funds from these accounts are then used to pay “qualified medical expenses” not covered by the medical insurance for an “eligible individual.” If these funds are not used, they roll over year to year. Once the taxpayer turns 65, the funds can be used like a retirement plan (taxable when withdrawn, but not subject to a withdrawal penalty) or saved for future medical expenses. Since the contribution is an above-the-line deduction, a taxpayer need not itemize to take advantage of this new tax break. The rules discussed here are applicable to federal tax returns and may not apply to your particular state.

• Eligible Individual – The new law defines an eligible individual as one who is covered by a “high deductible plan” and, while covered by that plan, is not also covered by another plan that does not have a high deductible. For purposes of determining if a plan does or does not have a high deductible, the new law allows certain types of coverage, such as workers’ compensation, insurance for a specific condition, dental care, vision, long-term care and certain others, to be disregarded.
  
  
• High Deductible Plans – For 2008, high deductible plans are defined as those with the following deductible amounts (2005 amounts shown):
  
  o Self-only coverage with an annual deductible of $1,100 or more and limits on annual expenses, other than premiums, required to be paid by the plan during the year, up to $5,600; or
  
  o Family coverage with an annual deductible of $2,200 or more and limits on annual expenses, other than premiums, required to be paid by the plan during the year, up to $11,200.
  
  
• Qualified Medical Expenses – Qualified medical expenses that can be paid from these accounts are generally defined as those that would be allowable as a medical deduction on your tax return.
  
  
• Contribution Limits – The eligibility and contribution amounts for these accounts are determined monthly. Therefore, during any month in which you qualify, you would be entitled to contribute one-twelfth of the annual limits. For 2008, the annual limits (note these values are adjusted annually for inflation) are either the lesser of the policy annual deductible or:
  
  o $2,900 for single coverage plans;
  o $5,800 for family coverage plans; and
  o $900 additional for individuals age 55 or older.
  
  Individuals entitled to benefits under Medicare and those claimed as a dependent on another person’s tax return cannot make contributions. Contributions can be made as late as the due date of the tax return without extensions; contributions in excess of the allowable amounts are subject to an annual 6% excise penalty. If your employer makes the contributions for you through a payroll deduction plan, the contributed amounts are not subject to normal payroll withholdings such as FICA and taxes.
  
  Example: John, a single taxpayer, age 58, begins a high deductible health plan with an annual deductible of $5,000 starting in March of 2008. We need to determine his maximum annual contribution limit, which is the smaller of the deductible amount or $3,800 ($2,900 plus $900 for being over 55). Next, we divide the annual limit by 12 to determine the monthly limit; in John’s case, it is $316.67 ($3,800/12). Since John was in a high deductible health plan for 10 months during 2008, his contribution limit for 2008 would be $3,166.70 ($316.67 x 10). If John were in the 25% tax bracket, he would realize a tax savings of $792.