What About Medical Savings Accounts?

Farm Business Management Update, December 1997

By Barbara J. Newton and David Kohl of the Department of Agricultural and Applied Economics, Virginia Tech

Lately we have heard a lot about this new thing called a Medical Savings Account (MSA), but not much information is available. Who can get one? Where do you get one? Do you even want one?

MSAs (also called Medical IRAs and Medisave Accounts) are accounts used to pay medical expenses. A new tax law passed in 1996 provides IRA-like tax treatment for deposits on MSAs. This plan allows uninsured and self employed individuals and employers with 50 or fewer employees to make contributions to a savings account with pre-tax dollars.

Congress has set a limit on the number of qualified MSAs that can be purchased. Only 750,000 people can enroll for 1997 and 1998. Those people enrolling before the deadline remain tax-advantaged indefinitely. As of September, only about 17,000 new MSAs were opened. The problem is that many small businesses and individuals are unfamiliar with what MSAs are or how they work. Consequently, they have not been asking health insurers about them.

How Does It Work?

The higher the deductible, the lower the insurance premium. Individuals can purchase a policy with $1,500 to $2,250 deductible; families purchase a policy with $3,000 to $4,500 deductible. The difference in premium between a traditional policy and a higher deductible one is deposited into a tax-favored savings account. That money will grow or be used to pay for medical bills not paid due to the high deductible. Usually, a bank affiliated with the insurance company provides administrative services like the checks. Money remaining in an account at year's end may be saved for future health-care expenses, or may be withdrawn to spend it on other things. These withdrawals, however, are subject to income tax.

The intent of MSAs is to encourage you to reduce health care expenses by managing your money. Through MSAs the incentive exists to choose health care services rather than automatically accept many unnecessary services and allow insurance companies to worry about the expense.

What Are the Advantages?

• Contributions made by self-employed people or by employers (50 or less employees) are deductible.

• Withdrawals for medical care are not taxed.

• Interest earnings accumulate tax-deferred.

• Pre-tax dollars pay for deductible and co-insurance expenses.

• MSA money can be used to pay for medical expenses not typically covered by health insurance such as vision and dental care.

• MSAs reduce or eliminate the annual out-of pocket expenses like the deductible and co-insurance, allowing you to know your worst case expenses.

• As your savings grow, your worst case situation decreases.

• The tax law requires an annual Cost of Living Adjustment (COLA) based on changes in the Consumer Price Index.

• Unlike an IRA, no age limit is imposed at which funds must be withdrawn.

What Are the Disadvantages?

• Watch out for fees. Besides a monthly fee for writing a limited number of checks you pay extra for additional checks. And non-medical withdrawals are considered taxable income with a 15 percent tax penalty.

• You cannot use your account to pay for health insurance premiums unless you receive federal or state unemployment compensation or are entitled to health insurance continuation under C.O.B.R.A. But you can pay for qualified long-term care insurance.

• A minimum amount of money is required to open and continue your MSA account.

• If you contribute too much money--more than legally deductible from your taxes--the excess will be taxed as ordinary income with a 15 percent penalty.

• Usually a onetime set-up fee and a monthly administration fee is imposed.

• If you or a family member is sick a lot during the first few years, you will not see any savings growth.

Tips for Picking a Plan

• Choose the lowest deductible possible. Choose a company that has been providing health insurance for a long time and is "A" rated by A.M. Best.

• Choose a company that processes claims in ten working days or less.

• Choose a company that provided MSA programs before the new tax law went into effect.

• Choose a company that will provide all the year-end reporting forms, and make sure that they report all account activity to you on at least a quarterly basis.

• Be sure to carefully examine the provisions of coverage in any new policy. There may be some procedure limitations unacceptable to you.

• If you have to change insurance companies to a qualified one, you might not qualify at as good a rate.

Summing It Up

To start an MSA or not to start an MSA, that is the question. The best person to help you decide is your financial advisor. Whatever your decision, you should be an informed consumer of health care services.

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