Whether you're employed by a large corporation, a small company or you work for yourself, chances are you can funnel money through a special tax-deferred account that can save you one-third or more on your health care costs.

About three-fourths of large employers offer flexible spending accounts that let employees set aside pre-tax dollars for out-of-pocket health care expenses. And the self-employed or those employed by a company with fewer than 50 workers can take advantage of medical savings accounts, which is similar to an FSA. And some employers are offering a new kind of account -- the health reimbursement arrangement.

Flexible Spending Accounts

In a flexible spending account, money is deducted from your paycheck on a pretax basis to pay for out-of-pocket expenses, such as insurance co-payments and deductibles, as well as for qualified medical costs that may not be covered by your health insurance plan -- for instance, orthodontia, elective surgery, eyeglasses and contact lenses.

The IRS also changed the rules to allow people to use FSA money on certain non-prescription drugs, too. Antacids, pain relievers, allergy medicines and cold medicines count; toiletries and vitamins don't. Before you go to the drug store, though, be sure to check with your plan's administrator.

Contributions to an FSA are not subject to federal income or social security and medicare taxes. Funneling money through a plan can save you one-third or more on your health care costs.

The drawback is that any money committed to the plan but not spent by the end of the year is forfeited. (A modification gives a company the option of offering its employees a grace period of two and a half months in which they can use up the money in the account.) Our flexible spending account calculator will help you figure out how much to set aside.

The use-it-or-lose-it rules for flexible-spending accounts cut two ways. The entire amount you designate to your FSA is available starting January 1, even though your contributions are spread throughout the year. So if you use the whole amount then leave your job before the end of the year, your employer has to eat the difference.

Health Savings Accounts

Because insurance costs are so high, it makes sense for healthy individuals and families to go with a high deductible health insurance policy and stash the premium savings in a health savings account (HSA). These plans became available in 2004 and are available both for the self-employed and company employees.

To qualify for an HSA, you must be under age 65 and purchase a health policy with an annual deductible of at least $1,100 for an individual or $2,200 for a family. This policy must be your only health insurance. Once the policy is in place, you may set up an HSA and contribute up to an amount that is indexed annually for inflation. If you are age 55 or older by the end of the year, you may contribute an amount (set by the IRS) beyond the deductible. See IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans for annual amounts.

Money you put into the account can be deducted on your tax return regardless of whether you itemize deductions. Earnings in the account grow untaxed, just as in a 401(k) or IRA. But unlike retirement plans, you can dip into an HSA at any age -- tax-free -- to pay for medical expenses, including your policy deductible and co-payments and many charges that are not typically covered by health insurance, such as over-the-counter drugs, vision and dental care, long-term-care insurance premiums, and future Medigap premiums.

Unlike flexible spending accounts, HSAs allow unspent money to be rolled over from year to year. You will owe income tax on earnings if funds are used for non-health-care purposes, and a 10% penalty will be imposed on any nonqualified withdrawal before age 65.

You can't have an HSA if you use a flexible-spending account to pay health care costs with pretax dollars or if you have other medical coverage (say, through a spouse's policy). However, if your FSA restricts reimbursements to wellness care (such as annual physicals) and vision and dental care, you can have an HSA, too.

After age 65 any that's left in the HSA may be withdrawn penalty-free for any purpose, but earnings not used to pay medical bills will be taxed.

For more information, see Health Savings Account Answers.

When Cobra Kicks In

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