Harold Laudien

RISING HEALTH CARE COSTS ARE a top concern for many individuals in the <?xml:namespace prefix = st1 />

 today. Who should bear the cost of health care that is forecasted to rise at 2 to 3 times inflation?employers or employees? One possible solution to help lessen the burden on both is a health savings account (HSA).

The HSA was established as part of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003. The benefit of establishing an HSA is that savings used for qualified medical expenses for employees, spouses, and dependents are free from federal income taxes.

Individuals younger than age 65 are eligible to contribute to an HSA if they are covered by a high-deductible health plan (HDHP), not covered by any other health plan, and cannot be claimed as a dependent on another individual?s tax return. An HDHP has a deductible of $1100 for individual coverage or $2200 for family coverage in 2007 and has caps on out-of-pocket expenses. Currently, the contribution limit per year is $2850 for individual coverage and $5650 for family coverage. Individuals aged 55 to 64 years are able to contribute an additional $800 in 2007. Contribution limits are indexed annually for inflation, which is another benefit of the HSA plan. If an individual creates an HSA and later becomes ineligible, additional contributions are prohibited, but they may continue to maintain the existing account. Unused balances can be rolled over from year to year, unlike a flexible spending account (FSA). The Table below is a hypothetical example of how contributions to an HSA could build over time.

be paired with HDHPs, many participants will need to use these funds annually to satisfy medical expenses below the deductible. The likelihood of building up assets in the account may be very low, as all but the wealthiest participants can afford to both contribute to an HSA and pay several thousand dollars of current medical expenses out of pocket.

Withdrawals from an HSA are tax-free if used for qualified medical expenses?generally those that would qualify for a medical or dental tax deduction. Distributions not used for qualified medical expenses are subject to income tax and a 10% penalty. The 10% penalty is waived in the case of death, disability, or distributions made by individuals 65 years of age and older.

HSAs are portable and allow participants to roll over accounts as long as the process is completed within 60 days. Rollovers also may be made from Archer Medical Savings Accounts and some FSAs or Health Reimbursement Arrangements from 2007-2011 with some restrictions. Permitted investments are similar to those for individual retirement accounts (no insurance, no collectibles, etc). Interested individuals should contact their HSA administrator to understand what restrictions on rollovers or investments may apply.

More information is also available in IRS Publication 969, 

Health Savings Accounts and Other Tax-Favored Health Plans, 

which can be downloaded from www.irs.gov.

Articles

Mr. Laudien is a financial advisor with Merrill Lynch in Princeton, NJ, member of Securities Investor Protection Corp.

HEALTH SAVINGS ACCOUNTS: AN ANSWER TO RISING HEALTH CARE COSTS

FINALLY, THAT FULL-TIME JOByou worked so hard to earn throughmany years of higher education isoffered to you. You hastily accept theoffer and look forward to getting yourfirst paycheck. Once you start your job,you are given a slew of documents thatcover all of your personal information,taxes, automatic deposit, and the401(k).You may have heard of a 401(k)plan, but how does it work?

A traditional 401(k) plan allows eligibleemployees to make pre-tax electivedeferrals through payroll deductionsand invest that money using variousinvestment vehicles during the courseof their employment.One of the biggestadvantages of participatingin a 401(k)plan is the ability todefer paying taxesuntil you withdrawthe money. Reviewthe Table for a comparison.

This hypothetical example illustratesan 8% rate of return on a $4000 annualinvestment for 40 years. If you werein the 25% tax bracket, you would seethat after 20 years of investing $4000annually, tax deferral would putapproximately 27% more in theaccount than if the earnings were taxedeach year. With a 401(k), if you tookwithdrawals at the end of 40 years, youwould owe income taxes. If you withdrewthe money all at once and paid thetaxes at the 35% rate, you would end upwith $71,240 more than you wouldhave with a taxable account.Lower tax rateson capital gains anddividends may resultin more favorable returnson taxable investments,thereby reducingthe differencein performance betweenthe accountsshown. You shouldconsider your personalinvestment horizonand income tax brackets,both current andanticipated, when making an investmentdecision.

Other details within the structure ofa 401(k) that you should be aware ofinclude:

—For 2006, you are allowed tocontribute $15,000. Amounts areindexed for inflation in the year2007 in $500 increments.

—Not all employersmake matching contributions,and the companies that do maycontribute at different levels. Atypical match may be 25% to 50%of the employee's contribution upto a certain level.

—Employee contributionsare always 100% vested, while theemployer's contribution is subjectto a vesting schedule. It typicallytakes 3 to 5 years to be fully vestedand earn the full portion of youremployer contributions.

—Each plan isdesigned to give you the ability todiversify your money. A typical401(k) may have company stockoffered along with various otherinvestment options. It is importantto consider your risk tolerance. Doyou want to be a conservative,moderate, or aggressive investor?Ask questions about the investments,such as the past investmentperformance and how much itcosts each year to own it before youcommit your money to it.

—Your investment allocationwill change over time as themarkets shift. In order to keep inline with your overall strategy, it isimportant to rebalance your portfolio.Many plans now offer an automaticfeature that will rebalance theaccount on a semiannual or annualbasis, or you can do it manually.

A substantial number of companieshave adopted 401(k) plans in recentyears. Visit individual pharmacy Websites to find out more detailed information.To learn more about 401(k) plans,visit www.irs.gov and search for "Topic424" or visit the US Department ofLabor site at www.dol.gov. 

Mr. Laudien is a financial consultant with A.G. Edwards & Sons Inc, inPrinceton, NJ, Member SIPC. Harold Laudien.  Mr. Laudien welcomes questions or comments.For more information, please contact him at800-722-3933 or visit www.agedwards.com/fc/harold.laudien.