Medical Savings Accounts

If you qualify, there’s a way in which you can pay for some of your health expenses on a tax-free basis. It’s called a Medical Savings Account. Also known as an Archer MSA, it’s generally available to self-employed individuals or people who work for small companies that have fifty or fewer employees and offer no group health insurance. Your company can provide the MSA or you can set one up for yourself. It can be somewhat more expensive, however, when compared to group insurance bought through an association or an individual major-medical health plan.

An MSA operates in this manner: you must first buy a high-deductible health plan (HDHP). For an individual plan the deductible can range from $1,700 to $2,650 per year. Family-plan deductibles must be at least $3,500 to a maximum of $5,250 yearly (the deductible is the amount that you pay out-of-pocket before the insurance picks up the coverage and begins to pay). You may also have to pay a percentage of each medical bill. However, annual out-of-pocket expenses are capped at $3,500 for individuals and $6,450 for families. (All of these amounts are indexed to inflation.)

Once you have the HDHP, you open a tax-deductible medical savings account. Each year you’re allowed to deposit up to seventy-five percent of your deductible amount for a family plan (sixty-five percent for the individual plan) into the account. The funds are held by a custodian -- usually a bank or the insurer. Or, your employer can make deposits on your behalf. In this case, the money is free of Social Security tax. Either way, you earn tax-deferred interest on the deposited money. However, if your employer deposits less than the maximum allowable amount, you cannot add to it. You and you employer can’t both make deposits into your account during the same year.

Whenever you have a qualified medical expense, you use the funds in your MSA to pay for it. Any money not spent during the year carries over to future years. You can also use your MSA for expenses not covered by your insurance, such as eyeglasses or vanity cosmetic surgery. But money for uncovered items or procedures won’t count toward your deductible.

Funds in your MSA can be used for nonmedical reasons, as well. But if this happens, you must report the expenditure as taxable income. You’ll also owe a fifteen percent penalty unless you’re at least 65 years old or are disabled.

Your MSA is portable, which means that if you change employers your account goes with you. But if your new company isn’t eligible to have medical savings accounts, you’ll no longer be able to make contributions. You can, however, still use the money already deposited to pay for qualified medical expenses tax-free. Or, you can allow the funds to continue to build until retirement on a tax-deferred basis.

For healthy people with plenty of money, MSAs can be a great savings tool. They can be somewhat risky, however, for those on a tight budget. With high deductibles and stiff penalties for using the money for nonmedical needs (even financial emergencies), many people may see very little advantage to them.