Mastering the Insurance Maze, Part 2:
How a Health Savings Account Can Save You Thousands Next Year

Last Week, I talked about how you can find affordable, high-quality individual insurance coverage. This week, I'll tell you how to pair your individual plan with a Health Savings Account – and save yourself thousands of dollars each year.

The 2003 Medicaid Bill included a provision creating Health Savings Accounts (HSA). These accounts have attracted little press. Corporate employers mostly ignore them. But an HSA will save our self-employed family more than $2,400 next year – and it could do the same for you.

Tax-Free Savings and Flexibility

An HSA allows you to put aside pre-tax money for medical expenses. It's similar to the Medical Savings Accounts (MSAs) the government is phasing out. And it is, in fact, better.

Your contributions to an HSA are tax deductible – and you can claim the deduction even if you don't currently itemize your deductions. The funds can be invested, and all earnings are tax-free as long as you use them to pay qualified medical expenses.

The scope of what qualifies is wide. You can use HSA funds to pay ANY out-of-pocket medical expenses – including what you spend to meet your deductible. Plus, you can use these funds to pay for expenses like dental and vision care, acupuncture, non-prescription medicines … even bandages.

Any HSA funds you haven't used at the end of the year are yours to keep in the account. Leftover dollars accumulate – building an emergency reserve for future medical expenses. Once you reach age 65, you can use the funds for any type of expenses – not just medical. And when you die, any unused funds go to your designated beneficiary.

Almost everyone is eligible for HSA enrollment. If you change insurance plans or providers, or go back to group coverage – the HSA stays with you. This is especially important for freelancers, because you're not locked into any one insurance provider. And if you're an employee, the HSA is yours to keep – even if you switch jobs.

How to Know if You Qualify

To qualify for an HSA, you must pair it with what the IRS terms a "High Deductible Health Plan" – although it's really not that high. The minimum deductible that qualifies is $1,000 for an individual and $2,000 for a family.

Your insurance policy must have a provision that limits out-of-pocket expenses to a maximum of $5,000 for an individual and $10,000 for a family. Also, you cannot be eligible for Medicare benefits, nor can you be claimed as a dependent on someone else's tax return.

Remember, the higher the deductible you choose, the lower your monthly premium. Most insurance providers offer a range of deductible/premium combinations so you can choose the one that best fits your situation.

How Much You Can Expect to Save?

Here's an example, using my family, of how the savings can work:

We live in Colorado. A traditional insurance plan for a family of four with a $500 deductible and a co-pay of 20% costs approximately $5,900/year.

Our HSA plan, on the other hand, has an annual premium of $3,500, a deductible of $3,450, and zero co-pay.

Assume we have a relatively healthy year and incur $1,000 in medical expenses. Insured under a traditional plan, we're out $6,500 total at the end of the year. Insured with an HSA, we're out just $4,100 (including the $400 tax savings). The HSA saves us $2,400 per year.

Traditional Plan High-Deductible Plan With HSA
Annual premium $5,900 $3,500
Amt toward deductible 500 1,000
Co-pay @ 20% 100
Total out-of-pocket 6,500 4,500
Less tax savings @ 40% (400)
Net expenses 6,500 4,100

Say, however, I undercook the chicken dinner and everyone in the family lands in the hospital – with expenses of $3,500.

This exceeds our deductible with either insurance plan. Net out-of-pocket expenses for either plan are roughly equal. But with the HSA, that deductible is covered with pre-tax dollars – and that represents a savings of more than $1,400.

Traditional Plan High-Deductible Plan With HSA
Annual premium $5,900 $3,500
Amt toward deductible 500 3,450
Co-pay @ 20% 600 0
Total out-of-pocket 7,000 6,950
Less tax savings @ 40% (1,380)
Net expenses 7,000 $5,570

So with an HSA, whether you save a lot or a little, each year's savings accrues interest. This builds a nest egg you can use for future medical expenses or in retirement.


Consumers currently under group coverage have largely ignored HSAs. The United Health Group – the largest insurance provider in the U.S. – estimates that fewer than 1% of its insured will choose an HSA.

That's because most employers pay a portion of their monthly premiums. There's no incentive for a worker to reduce the subsidized premium in return for a higher deductible. But being self-employed, you don't have that option.

Health-policy experts have been critical of HSAs. They don't refute the cost savings. Their concern is the effect on public health. They point out that the best way to prevent sickness and high medical costs is through regular preventative examinations.

HSA plans don't pay for preventative maintenance costs until the high deductible has been met – so the concern is that people will put off doctor visits until they're sick.

While this is a risk for the public in general, it is a manageable risk if you're informed.

Don't skimp on regular check-ups and health screenings. You may pay a few more out-of-pocket dollars for them, but they'll be pre-tax dollars. And what you'll save with lower premiums will more than outweigh these costs.

In healthy years, low premiums allow you to increase your savings on a pre-tax basis. In years with high medical costs, you are no worse off than you would have been under a traditional plan.

The bottom line is that these programs can save you thousands of dollars every year. Like IRAs and 401(k)s, HSAs provide a way to save more of your pre-tax income.

Even if you don't have the funds right now to set aside any savings, you can still use the plan as a way to reduce your income tax. Use pre-tax dollars to pay medical expenses you would have incurred anyway. You'll reduce the amount of money going to the government – and keep more in your own pocket.

[Ed. Note: AWAI graduate Patrick Stevens is a freelance writer and consultant. He has 12 years of business experience as a corporate finance and marketing executive. Pat recently moved with his wife Jen to Colorado ("where we always wanted to live"). Pat and Jen work from home and take care of their 3-year-old and 5-month-old boys.]

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Published: December 13, 2004

1 Response to “Mastering the Insurance Maze, Part 2: How a Health Savings Account Can Save You Thousands Next Year”

  1. Patrick Stevens' articles Mastering the Insurance Maze Part 1 and 2 were insightful. Thanks for taking the time to research and share this info Pat! Can you, or anyone else in the AWAI community, share your current experience with health insurance for the freelancer? Thanks in advance!


    Eli Kirtman

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