Health Insurance

Here's the lowdown on the new tax-exempt medical savings accounts

One of the biggest battles of last year's health-care-reform law was over medical savings accounts (MSAs). After much heated rhetoric, Congress authorized a set number of these new tax-exempt accounts, for use by businesses with 50 or fewer employees and the self-employed. That leaves most small-business owners with a new set of questions: what are MSAs, anyway--and should my company get some?

Don't panic. An MSA is basically a retirement savings account that can be used to pay health-care bills. A company owner's contributions to an MSA are tax-free to employees as long as they're used for medical expenses. If employees take the money out as a year-end bonus, they'll have to pay income tax and a 15% penalty. After age 65, there's no penalty for nonmedical withdrawals, but the funds withdrawn are taxed.

MSAs come with a highdeductible "catastrophic" insurance policy. Deductibles can range from $1,500 to $2,250 for single people and from $3,000 to $4,500 for families. Since high-deductible policies cost less than low-deductible ones, you may be able to switch to a high-deductible plan and contribute the maximum annual amount to your workers' MSAs (65% of the deductible for single coverage and 75% for family policies), and still save on health-care coverage.

Congress has stipulated that only 750,000 MSAs can be set up during the next four years. Should you rush out and call your insurance broker?

Ken Myers, owner of MasterLab, a one-hour photo studio in Indianapolis, would probably say yes. Myers had set up his company's MSAs before Congress made the accounts tax-exempt. He says he saved 40% on insurance costs in 1996 by purchasing high-deductible coverage and establishing MSAs for himself and five employees.

In addition, Myers's insurance carrier administers his MSAs. All Myers has to do is write two checks a month, one for the insurance premium and the other to cover his MSA contributions. The carrier pays a fixed rate of interest on the account after the first year. Some insurers also provide a menu of investment options.

Are you a good candidate for MSAs? If you currently carry low-deductible indemnity insurance, switching to an MSA/high-deductible plan may bring you significant savings. A rule of thumb is that premiums drop by $300 to $400 for each $1,000 rise in the deductible, but the actual figure will depend on the coverage and the deductibles.

If you currently belong to a health-maintenance organization, switching is not likely to result in enough savings to fund MSAs. And your workers are paying low out-of-pocket costs as it is.

Two groups will really benefit from tax-exempt MSAs: The healthy will do better because they'll be able to build up a retirement nest egg in their MSA. And the self-employed, who up to now could deduct only 30% of their health-plan premiums, will gain a bigger tax advantage by sheltering some of their insurance money.

What are the downsides to MSAs? The law sets an out-of-pocket limit of $5,500 for families and $3,000 for single people with MSA/catastrophic plans (to protect people whose insurers require copayments above the deductible). But if you or your employees need medical care that isn't covered by your policy, those out-of-pocket maximums don't apply. The quandary is that the cost of comprehensive coverage reduces the savings you get from buying a high-deductible policy.

What's more, MSA payments for benefits not covered by your policy can't be applied to the deductible. So even routine eye tests and dental checkups, if not covered, can nibble away at an MSA without running down the deductible.

How a Typical MSA Works

  1. The employer pays the catastrophic-insurance premium and contributes to the medical savings account (MSA).
  2. The insurance company sets up MSAs for individual employees and invests the funds.
  3. When the employee has a medical bill, his or her health-care provider sends it to the insurance company, and the employee advises the insurer that funds should be withdrawn from his or her MSA.
  4. The insurance company sends the funds either to the health-care provider or to the employee as reimbursement.

Ken Terry is a senior editor at Medical Economics magazine.

Resources: Want to learn more about medical savings accounts (MSAs) before contacting your insurance broker? The National Federation for Independent Business (600 Maryland Ave. SW, Suite 700, Washington, DC 20024; 202-554-9000) is a lobbyist for MSAs. Another lobbying group is the Council for Affordable Health Insurance (112 Southwest St., Alexandria, VA 22314; 703-836-6200). Both are knowledgeable about MSAs. So is the think tank the National Center for Policy Analysis (12655 N. Central Expressway, Suite 720, Dallas, TX 75243; 972-386-6272).

If you're interested in the pros and cons of MSAs from a policy perspective, you can read the discussion that Elizabeth Farnsworth of public broadcasting's The Newshour led with Dr. Daniel Johnson Jr., the president-elect of the American Medical Association, and Gail Shearer, the director of health-policy analysis for Consumers Union, before the legislation was passed. It's available at PBS's Web site.

MASTERLAB, Ken Myers, 9713 E. Washington St., Indianapolis, IN 46229; 317-898-4161