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Health Savings Accounts

The Medicare Prescription Drug, Improvement, and Modernization Act signed by President Bush on December 8, 2003 creates a federal income tax deduction for contributions to health savings accounts, effective January 1, 2004. These accounts are similar to IRAs, and may provide even greater benefits. They should prove every bit as popular.

Health savings accounts are tax-free savings accounts that you establish and control. Your contribution to the account is deductible, and the interest it earns is tax-free. Amounts distributed are never taxed, making them better than IRAs, as long as distributions are used to pay for qualified medical expenses, such as health insurance deductibles, co-payments for medical services, prescriptions, or other health products. They can be used to purchase over-the-counter drugs and long-term care insurance, and to pay health insurance premiums. Funds may accumulate and grow tax-free from year to year. The funds are portable so that they go with you even if you change jobs.

Of course there are limitations and requirements. There is a contribution limit of $2,600 per year for individuals and $5,150 for families. (Individuals over 55 can make extra contributions to their accounts to “catch up.”) They are only open to individuals covered by a “high deductible health insurance plan”, however, this will not exclude many taxpayers. The annual deduction for a “high deductible health insurance plan” must be at least $1,000 for individual coverage and $2,000 for family coverage. Annual out-of-pocket limits must be less than $5,000 for individuals and $10,000 for families. Most people should be able to comply with these requirements