Health Savings Accounts (HSAs).⁴² As of January 1, 2004, 250 million nonelderly Americans, at least in principle, have access to HSAs, provided they are combined with catastrophic insurance coverage. HSAs allow individuals and employers to make annual deposits up to the health insurance deductible. The health insurance policy accompanying an HSA must have an overall deductible of at least $1,000 for an individual or $2,000 for a family policy. A typical plan works like this: When individuals enter the medical marketplace, they spend first from their HSA. If they exhaust their HSA funds before reaching the deductible, they then pay out-of-pocket. Once they reach their deductible, insurance pays all remaining costs.

Annual HSA tax-free deposits typically cannot exceed $2,650 for individuals and $5,250 for families.⁴³ The account balances can be invested in stocks and bonds and other financial assets, and they grow tax free. Thus a young person could accumulate hundreds of thousands of dollars by the time he or she retires.⁴⁴

HSA balances belong to the individual account holders and remain theirs if they switch jobs, become unemployed or retire. The funds can be used to pay expenses not covered by insurance, insurance premiums while unemployed and health expenses during retirement. In the event of death, HSAs may be bequeathed to a spouse, or (like an IRA) the funds may flow to other heirs.

Flexible Spending Accounts (FSAs).⁴⁵ Flexible spending accounts allow employees to set aside money tax-free for anticipated medical needs. FSAs are strong in areas where HSAs are weak — and vice versa. Though FSAs have no insurance requirement and no funding limits, they may be used only for medical expenses. Moreover, employees forfeit any funds left in the FSA at year’s end or when they leave their job. This use-it-or-lose-it rule encourages workers to spend in wasteful ways. FSAs would be more attractive to workers (and would come closer to leveling the playing field) if they were made portable from year to year, and from job to job.

Health Reimbursement Arrangements (HRAs). A June 2003 IRS Revenue Ruling clarified that HRAs funds could be rolled over tax free. They are similar to FSAs, with important exceptions. Unlike FSAs, only employers may contribute to HRAs. At an employer’s discretion, workers may roll over unspent HRA balances from year to year and may have access to leftover balances after they leave a job. Although HRAs are more flexible than FSAs, in the long run they too are governed by a use-it-orlose- it rule. The funds can be spent only on health care or insurance premiums and can never be withdrawn as cash.