A Health Savings Account allows you to reduce your taxes while putting aside money for medical expenses.

You get a tax deduction when you contribute to the account, money grows tax-free through investment and withdrawals for qualified expenses aren’t taxable. The maximum contribution in 2008 is $2,900 for individuals and $5,800 for families. If you’re 55 or older, you can make an additional catch up contribution of $900.

President Bush created Health Savings Accounts in 2003 when he signed the Medicare Prescription Drug Act into law. The purpose: Give individuals more control over their money and encourage the uninsured to buy health coverage. Unlike many other tax breaks, there are no income limits for HSAs.

“HSAs reduce government’s influence over consumers’ medical decisions by reducing the price distortions created by the federal tax code,” says analyst Michael Cannon in a Cato Institute report. “However, HSAs as they exist today do not eliminate those distortions. Current HSA law restricts consumers’ health insurance choices, makes it difficult for the chronically ill to save for future medical needs and discourages cost sharing above the health insurance deductible.”

Health Savings Accounts link high deductible health insurance with a tax-free savings account to cover out-of-pocket medical expenses. Unused money rolls over from year to year and grows tax-free. Flexible Spending Accounts are similar, but you must spend the money by the end of the year or lose it. You can open a Flexible Spending Account only through your employer, but Health Savings Accounts can be set up on your own through banks, credit unions or insurance companies.

Eligibility to contribute to a HSA is determined by the effective date of your high deductible health plan. If you don’t have such coverage for the entire year, you won’t be able to make the maximum contribution and all contributions, including a catch up, will be pro-rated. However, contributions can be made as late as April 15th of the following year. For 2007, the maximum contribution is $2,850 for individuals and $5,650 for families.

In general, health insurance with a high deductible is cheaper than coverage with a low deductible. Buying high deductible coverage will save you money - and that’s before the tax savings from contributing to the HSA. To establish a Health Savings Account, your health plan must have an annual deductible of at least $1,100 for individuals and $2,200 for families in 2007.

If you haven’t met your deductible for the year, funds in your HSA can be used to pay it. When the deductible is paid, your insurance plan kicks in to cover medical costs listed in your policy. However, HSA money can still be used to meet co-pays. How payment is made depends on your health plan and its providers. In general, you can tap money in your HSA account by debit card, check or withdrawal request.

A Health Savings Account allows you to see the doctor of your choice as needed. However, HSAs aren’t a good choice for the chronically ill because the money probably would be spent in full each year and there would be little opportunity to set aside money in the future.

Health Savings Accounts are portable and you can keep the money if you change jobs, switch medical insurance companies, lose your job, move to another state or change your marital status.

You can have your tax refund deposited directly in your HSA or split it between your HSA and IRA to meet your changing needs from year to year.

When you die, your spouse becomes the owner of the account and can use the money. If you’re single at the time of death, the money goes to your beneficiary or becomes part of your estate. However, money in the account may be subject to taxes if it goes through probate.

In general, you can’t use HSA money to pay medical insurance premiums, including COBRA continuation coverage, after leaving a job that provides health coverage. But you can use it to pay for medical expenses for yourself, your spouse or your children.

The number of people using HSAs grew to 4.5 million in 2007 from 438,000 in 2004, the first full year the program was available. The number of participants is expected to grow to 14 million by 2010.

A study by the Government Accounting Office found that HSAs aren’t for everyone. In 2004, 51% of tax filers reporting an HSA contribution had an adjusted gross income of $75,000 compared with 18% of all filers under 65.

“Most participants were satisfied with their HSA-eligible plan and would recommend these plans to healthy consumers, but not to those who use maintenance medication, have a chronic condition, have children, or may not have the funds to meet the high deductible,” the GAO report says.

Shop wisely for a high-deductible insurance policy. With a few clicks, you can compare coverage by Blue Cross/Blue Shield with Aetna (AET), Cigna (CI) and UnitedHealth Group (UNH).