How does a Health Savings Account (HSA) work?

With an HSA you can make tax-deductible contributions each year to pay for current and future health care costs. What you don't use in any given year will stay invested and continue to grow tax-free, assuming you eventually pull it out to use for medical costs. If you use any withdrawal for non-medical costs it will be taxed when you use it - and if you are not yet 65, you'll owe a 10% penalty too. So draw on the account to pay medical costs only.

The annual contribution limit to an HSA in 2008 is $2,900 for individuals and $5,800 for families. If you are at least 55 years old you can contribute an additional $900 in 2008. That catch-up contribution will rise to $1,000 in 2009. Many employers offer an HSA plan. If yours doesn't (or if you are self-employed), you can shop for a plan on your own; check out sites such as ehealthinsurance.com.

If your employer offers an HSA, it typically works just like a traditional 401(k): Your contribution is taken out of your paycheck on a pre-tax basis. Your employer may also kick in a contribution. If you have an HSA on your own, you still get the tax break; you just claim the contribution as an "above the line" deduction on your tax return, and your taxable income will be reduced by the amount of your contribution.

What's more, just about anyone can contribute to your HSA: spouses, parents, even friends. (Now that would indeed be a very good friend.)