MEDICAL SAVINGS ACCOUNTS

Medical Savings Accounts (MSA) increase access to preventive care, promote wellness, and control costs without jeopardizing the quality of medical care. With the changes in tax laws, many Americans will now be able to enjoy the full benefits of MSAs.

MSAs were around long before Congress gave its seal of approval. More than 25,000 people were already MSA policyholders before the passage of the Health Insurance Portability and Accountability Act of 1996, commonly known as the Kassebaum-Kennedy bill. This simple concept was first introduced to employer groups as a health insurance plan by Golden Rule Insurance Company in 1992. At the time, there was no tax benefit associated with the MSA plan.

The Health Insurance Portability and Accountability Act of 1996 (HIPA) included provisions for employee continuation of medical insurance, access to long term care services and promoted the use of Medical Savings Accounts (MSA).

• What is an MSA?

The basic idea behind MSAs is to move from a low-deductible plan to a high-deductible plan. An MSA is a tax exempt trust or custodial account set up with a U.S. financial institution (e.g. bank or insurance company) in which you can save money exclusively for future medical expenses. This account must be used with a high deductible health plan (HDHP).

• How does the new law affect MSAs?

The law created as a “pilot program” for MSAs that was scheduled to end December 31, 2002. The pilot program has been extended until December 31, 2003.

• Who can participate in the MSA program?

It is available to small employers (those with 50 or fewer employees) and to self-employed individuals. All employers under common control are considered to be one employer.

• What if a small employer becomes large?

A small employer that grows beyond 50 employees after it establishes an MSA/Catastrophic program may continue the program until it reaches more than 200 employees.

• Who can contribute to the MSA?

Either the employer or the employee can pay for the catastrophic policy and/or contribute to the MSA. Contribution limits are the same whether the employer or the employee contributes. Individual contributions are deductible (within some limits) in determining the individual’s adjusted gross income (i.e., “above the line”). In addition, employer contributions are excludable (within the same limits), except that this exclusion does not apply to contributions made through a cafeteria plan. Employer and employee contributions are not permitted during the same year.

• How does the MSA program work?

The savings account is used to pay routine, qualified medical care. Qualified medical expenses are defined in the IRS Tax Code 213(d) and include eyeglasses, dental visits, and preventive care. If all the money in the account is spent, the insured pays a limited amount out-of-pocket until the deductible is met. After the deductible is met, the insurance policy pays 100 percent of covered expenses. An MSA program participant must be covered by a high-deductible catastrophic health insurance policy. After a policy is in place, either the employer or the individual can contribute up to 65% (75% for family coverage) of the individual catastrophic policy’s deductible into a tax-favored MSA.

• What is considered a “high-deductible” policy?

A “high-deductible” catastrophic health insurance policy is defined as a policy that has a deductible of at least $1,650 ($1,700 for 2003) and no more than $2,500 for individual coverage; and at least $3,300 ($3,350 for 2003) and no more than $4,950 ($5,050 for 2003) for family coverage.

• How are contributions and withdrawals treated?

Earnings on contributions to MSAs accumulate income tax-free. Withdrawals form MSAs for “qualified medical expenses” (those that qualify as medical expenses under IRC Section 213, the tax rule that allows individuals to deduct medical expenses to the extent they exceed 7.5% of adjusted gross income) are also tax-free.

• What happens if the withdrawal is not for medical expenses?

Withdrawals from MSAs that are not for qualified medical expenses are subject to income tax, and, if they occur before death or age of Medicare eligibility, are subject to a 15% penalty tax.

• Can MSAs be offered through a cafeteria plan?

MSA/Catastrophic may be offered in conjunction with a cafeteria plan since a high deductible may be offered under a cafeteria plan. However, the MSA must be outside the cafeteria plan since a cafeteria plan is not permitted to provide for contributions to a MSA.

• When do MSA balances become taxable?

MSA balances become taxable income if/when an MSA participant does not have high-deductible catastrophic coverage.

• Can MSA funds be used to purchase LTC insurance?

Tax-free MSA withdrawals can be used to purchase Long Term Care insurance, but not to purchase other health insurance.

• What happens to participants if the enrollment cap is exceeded?

MSA participants (whether individual or employer) can continue their MSA programs (including making new annual contributions) even after the enrollment cap is exceeded (if it is) and after the year 2003. The enrollment cap/cut-off will apply to new MSA program participants only.

• What are the tax benefits?

On August 21, 1996, President Clinton signed the Health Insurance Portability and Accountability Act of 1996. This law makes MSA contributions and withdrawals for qualified medical expenses tax-exempt. The law also limits the number of potential insureds to 750,000 people. Self-employed, groups with 50 or fewer employees, and uninsured are eligible to apply for a tax-advantaged MSA. The number of eligible uninsured does not count toward the 750,000 cap.

• How does an MSA benefit the self-employed?

The self-employed benefit most from the tax exemptions. Up until now, the self-employed had very little financial support from the federal government to purchase health insurance. In 1995, they could deduct only 25 percent of their premium payments. The deduction grew to 30 percent in 1996.

Now, with the MSA, contributions to the savings account are 100 percent tax-deductible. Premium for a high-deductible plan could be deducted at 40 percent in 1997. In 1998, it was 45 percent, 1999 - 65 percent.

In essence, the self-employed are given a pay raise with MSAs. Since the money they deposit into MSA is tax-free, an MSA plan requires less of the self-employed gross income when compared to traditional insurance. In addition, dollars remaining in their MSA account at year-end are theirs—an additional savings. Finally, those MSA deposits grow tax-deferred, which is an enormous advantage over time.

• How do MSAs benefit small groups?

An MSA works well for small groups because employers are able to provide a quality, comprehensive health insurance package without spending a lot of money. The MSA is a great benefit that can attract and retain good employees.

Small employers know it is extremely important to retain quality employees. Many employers are interested in MSAs. The BlueCross BlueShield Association surveyed a group of employers in December 1995 regarding MSAs. The survey found that 43 percent of employers would “definitely or probably” switch to MSAs and 67 percent were mildly interested.

Not only are employers interested, but also their employees are satisfied with the product. An independent study was taken of employees who were enrolled in the MSAs in 1995 to rate the MSA. A near-unanimous 97 percent were “extremely” or “mostly” satisfied with their health care coverage. Then in 1996, 93 percent of the covered employees enrolled in MSAs. Employees are able to choose their doctor without the restrictions HMOs demand. No gatekeeper has to provide permission to an insured to see a specialist, With an MSA, the insured makes the decisions, not the insurance company.

COMMENTARY

This law provides an opportunity for the self-employed and small businesses to combine catastrophic coverage with a pre-tax medical savings account. If the money in the savings account is not used for health care, the account holder gets to keep it. For the self-employed businessperson, this is the best chance in a long time to take care of you.

If the employee spends less, the money builds up in the account. He rolls it over at the end of the year, and can make another contribution the following year. The new law has prompted more than 50 insurers to offer high-deductible policies along with medical savings accounts. Both indemnity and managed care products are available. Some insurers provide both the insurance and the savings account; others team up with a bank.

Advocates say the new accounts will encourage more prudent health care consumption. However, opponents argue that the plans represent a giant step backward for health care in America. Some contend that the system will siphon off healthy consumers attracted by the chance to keep much of the money they would otherwise spend on health insurance premiums. The future is further clouded by the coming demise of the “pilot” program and uncertainty of the availability of new MSAs.

The law also created Medicare+Choice MSAs designated to be used solely to pay the qualified medical expenses of the account holder. As of this writing, however, Medicare has not approved a HDHP so no Medicare+Choice MSAs have been established.

Sources: www.irs.gov
www.medicare.gov

Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice.