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Health Care & Insurance

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How to make the most of a pretax health savings account.

Joe Bailey, a 48-year-old retired Sallie Mae executive from Shavertown, Pa., makes it a point to haggle over the bill at his doctor's office. When he needs to fill prescriptions, he asks the pharmacist about cheaper generic alternatives. And Bailey's hard-won savings go even further because he uses his tax-free health savings account to pay for his medical expenses.

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More than three million Americans already use HSAs, and a number of employers are offering them to employees in conjunction with high-deductible health-insurance policies to encourage smart consumer choices. You can contribute pretax dollars to an HSA, and withdrawals are tax-free when you use the money for medical expenses. Use the money for anything else and you'll owe taxes plus a 10% penalty, unless you're 65 or older.

You can also open an HSA on your own -- as long as you have high-deductible health insurance -- and get a tax deduction for your contributions, regardless of whether you itemize deductions. To qualify for an HSA in 2006, your health plan's deductible must be at least $1,050 for an individual or $2,100 for a family.

An HSA is a better deal than the more familiar flexible spending account because there is no "use it or lose it" rule; you can roll over the money from year to year. Your employer might even kick in money to your account.

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But to get the most out of an HSA, it pays to follow a few simple strategies. Many banks and insurance companies offer HSAs, so pay attention to setup, administrative and investment fees that can whittle away at your account's tax-free earnings.

Access to your money is often by check or a debit card tied to the account. Some firms offer a credit card for times when medical bills exceed the HSA balance. Don't use the credit option, which typically costs 9% to 12% in interest. Instead, work out a payment plan with the health-care provider. Bargaining may "freak them out," says Bailey, but it works. He saved 10% on a routine dental cleaning just by asking for a discount.

Most HSA-compatible health plans require you to meet your deductible before they cover prescription-drug costs. So sign up for a drug-discount card that covers your medications.