Dear self-employed and small-business owners,
There's a new way to cover your health costs which also offers tremendous tax advantages: The Health Savings Account, or "HSA". It was included in the massive Medicare legislation signed by President Bush in early December.

An HSA offers significant advantages over the so-called "Archer Medical Savings Account," created to help small businesses a few years ago. But HSAs also have applications for larger companies -- and their employees.

With an HSA, employees -- and their employers, if they choose -- contribute pre-tax dollars to an account earmarked for out-of-pocket health expenses. But according to Jay Nawrocki, a health law analyst at the tax information firm CCH, "The real advantage is the tax shelter these accounts provide."

That's because in addition to not paying any tax on your contributions, you also pay no tax on the earnings that accumulate in your Health Savings Account. Moreover, money not withdrawn to pay for medical care is carried over to the next year and can continue growing tax-deferred.

And, provided you use it for health-related expenses or to pay health insurance premiums, you pay [no tax] when you withdraw money, either. Furthermore, these accounts are completely portable and can move from job to job and even continue when you retire.

You can put a significant amount of money into an HSA -- up to $2,600 a year for a plan that only covers an individual and up to $5,150 for a family plan. There are even "catch-up" contributions for folks nearing retirement. Your money is typically invested in mutual funds.

Depending upon your age, family status, health, and whether your employer also made contributions, you could amass a substantial amount of money in an HSA in just a few years. The fact that you can maintain these accounts even after you leave your job means people can essentially pre-fund their retirement medical expenses before they retire. And do so completely tax-free.

Now here's the downside: not everyone is eligible for a Health Savings Account. In order to qualify, you can only be covered by a high-deductible medical insurance policy, either through your employer or one you purchase yourself as a self-employed person. "High-deductible" means the policy must not kick in until you have accumulated at least $1,000 worth of out-of-pocket medical expenses that year. The family deductible must be at least $2,000.

Each year, you are allowed to contribute as much as 100 percent of your deductible (again, up to a max. of $2,600 for an individual-only policy and $5,150 for a family policy) to your HSA. Employers are also allowed to contribute to their employees' account.

So including the catch-up contribution, someone age 55 with a family policy could conceivably contribute as much as $5,650 to their HSA account this year -- far more than they could contribute to an IRA, which may or may not be deductible and is always taxable- either when you make your contribution or when you make a withdrawal. Again, any money not used would be left in the account to grow tax-free.

This is even better than a Roth IRA because contributions to an HSA are made on a pre-tax basis and there are no income limits restricting who can take advantage of them!

Health Savings Accounts were designed to help employers reduce the sky-rocketing cost of employee health insurance. Obviously, the bigger the deductible a policy requires, the less expensive it's going to be. In addition to helping larger companies that already offer health insurance, HSAs might make it possible for small businesses, which often don't offer

any type of health insurance to at least provide some coverage. While employees would still be responsible for doctor visits and prescription medicines, they would have help paying for any major medical bills which could arise if surgery or hospitalization became necessary.

You can even withdraw money form an HSAs even if you don't use it for medical expenses. If you're under age 55, there is a 10% penalty and ordinary income tax; at age 65 and older all you would pay is ordinary income tax.

Clearly, HSAs would not be available to anyone who has decent health insurance through work because their deductible is too low. And, says Nawrocki, they're not a good idea for people who expect to incur significant medical expenses over the next year such as young families and individuals who are planning to become pregnant. That's because these anticipated expenses will use up the full amount of the deductible -- and the real advantage of these accounts comes from leaving as much money in them as possible in order to take full advantage of potential tax-free compounding. They're also not a good deal for people who can't afford the monthly contributions to an HSA.

But these accounts are a potential gold mine for, say, healthy folks who are young and earning enough to max out their contributions each year. Don't be surprised if during next year's benefits enrollment period your employer gives you the option of opting OUT of the company's standard health insurance plan. If you choose the high-deductible Health Savings

Account option instead, you could potentially sock away a bundle -- tax-free.

If you're interested in learning more about Health Savings Accounts, contact your financial advisor or insurance agent.

There will be more to come on HSAs, I promise. Just remember you heard it here first!


Dear Gail,

I have been trying to figure out some California State tax deductions that I can apply to next years taxes for my fiancée. I have been flustered trying to find out anything that can be deducted, as I was able to get a larger refund (proportionally) for her on her Fed taxes than her state taxes!! Are there any sources of info that I as her preparer can use to help position her for a better refund this year?

-Stranded in the Golden State

Dear Stranded,

I'm not surprised your fiance received a proportionately larger refund from the federal government than the state of California, which has one of the highest income tax rates of all 50 states. And don't be surprised if the same pattern is repeated this year. Thanks to the two major tax bills passed during President Bush's term in office, there has been a significant reduction in the income tax rates we're paying at the federal level. year.

You may recall that the 2001 Tax Act called for lower tax rates to be phased in over several years. Then legislation passed in 2003 accelerated those reductions, making the lowest rates immediately applicable, instead of waiting until 2006.

Someone in the 28-percent tax bracket in 2001, would now be taxed at a maximum rate of 25 percent. That's not a 3-percent reduction in your taxes, it's almost an 11-percent reduction! There were similar rate cuts for the other brackets, as well.

Unfortunately, I don't see tax cuts on the horizon in California. Even "Arnold-the-Terminator" probably won't be able to bring that about, especially since the state's finances were already a train wreck when he took office.

For information about tax breaks which might be available to your fiancee, check out the website of the California Franchise Tax Board, the state's equivalent of the IRS. You will find tons of information as well as any forms you might need at: www.ftb.ca.gov.

Good luck!


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The views expressed in this article are those of Ms. Buckner or the individual commentator, and do not necessarily reflect the views of Putnam Investments Inc. or any of its affiliates. You should consult your own financial adviser for advice regarding your particular financial circumstances. This article is for information only and is not an offer of the sale of any mutual fund or other investment.