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 Moreover, money not withdrawn to pay for medical care is carried over to the next year and can continue growing tax-deferred.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