As often happens to investment vehicles created by legislation, Health Savings Accounts (HSAs) have suffered under the complex regulations meant to discourage misuse. However, the accounts have potential to do more than simply allow investors to save and pay for health-care expenses with tax-free dollars. They offer a potential way for individuals to bridge gaps in health insurance coverage that may occur during times of unemployment or in retirement.

The Medicare Modernization Act of 2003 created HSAs. Anyone younger than 65 can open an HSA after purchasing a qualified high-deductible health insurance plan. An individual can maintain an HSA and be covered under other insurance policies, as long as that person doesn't "double dip" and have medical expenses paid by both insurance and the HSA.

To be considered "qualified" the insurance plan must have a deductible of at least $1,050 for individuals or $2,100 for family, and have a limit of $5,250 individual and $10,500 family for out-of-pocket expenses. Choosing a policy that qualifies can involve insurance and tax issues that should be discussed with professionals in those fields.

Contribution caps are the lesser of the insurance plan deductible or the IRS maximum. For 2006, the IRS max is $2,700 for individuals and $5,450 for families. Individuals 55 or older can make a $700 catch-up contribution in 2006.

Many employers offer flexibility spending accounts for medical expenses (and sometimes child care) that allow employees to set aside pre-tax dollars for medical expenses not covered by the company's health insurance, including premiums and deductibles. Unlike flexible spending accounts, however, HSA contributions and gains can be rolled from year to year--there's no "use it or lose it" requirement--and you retain ownership of the funds even if you terminate employment. If your employer offers a flexible spending account, you should take a description of the account requirements and restrictions when you discuss an HSA with your financial professional.

Because you establish an HSA independent of your employer, these accounts can provide a health care expense "safety net" should you terminate employment (voluntarily or involuntarily). They also provide retirees with another investment vehicle that offers tax deductions for contributions, tax-free growth and tax-free withdrawals for medical expenses. Withdrawals for nonmedical expenses after age 65 are still taxable, and a 10% penalty applies for nonmedical withdrawals before age 65.

If you plan to use HSA funds in the near term, a liquid, interest-bearing account like a savings account may be appropriate. However, if you don't anticipate an immediate need for all or part of your HSA funds, the accounts are self-directed, allowing you to use other investment options. Your financial professional can help you determine which investment vehicle best meets your needs.

According to a 2006 survey by Watson Wyatt and the National Business Group on Health, health care insurance premiums have been rising at two to three times the rate of inflation for the past five years. Understanding the complexities of health savings accounts may be one way to lessen the blow and prepare for the future.