Is an MSA Right for You?
Congress extends enrollment window for medical savings accounts.
By Bob Barry, CFP

Congress has extended through 2003 the time in which qualified Americans can open a medical savings account (msa) under a pilot program it started in 1996. Although MSAs are not the answer for every family facing rising health care costs, they may be the solution for some. People even may use MSAs to supplement retirement income.

What is an MSA and how does it work? An MSA is a tax-favored account designed for people who own high-deductible medical insurance policies. First, you take out a high-deductible medical policy on yourself or your entire family. Then you open an MSA through a financial institution or the insurance carrier issuing the policy. In addition to paying the premium, you contribute money pretax to the account to pay for out-of-pocket medical expenses such as doctor visits. Once your expenses exceed the annual deductible, the policy benefits kick in. You also can use the contributions to pay for tax-qualified medical expenses that may not count toward the deductible, such as eyeglasses. If your expenses are less than what you put in, your contributions accumulate yearly and can earn money.

What is a high-deductible plan under an MSA? The deductible limits for 2002 range from $1,650 to $2,500 for individuals and $3,300 to $4,950 for families. These amounts are adjusted for inflation. The maximum out-of-pocket expenses (de-ductibles plus any copayments) for allowed costs can't exceed $3,300 for individual coverage and $6,050 for families.

Who's eligible for MSAs? Self-employed people and owners and workers of businesses with 50 or fewer employees are eligible, as long as they are not covered by another medical plan. Some Medicare recipients also may qualify.

What are the tax benefits? Most of your plan contributions are pretax, meaning they are not counted in your taxable income. But there is an annual contribution limit: For individuals, it is 65 percent of the medical plan's deductible, and for families it is 75 percent. For example, if your deductible is $4,000, then you can contribute $3,000 a year to the plan pretax. Funding beyond that would be with after-tax dollars.

Withdrawals to pay for qualified medical care generally are tax-free. Withdrawals not used for medical expenses are taxable as regular income. A 15 percent penalty is imposed unless you are disabled, over 65, or dead.

How does an MSA save me money compared with a traditional insurance policy? Usually, the higher the de-ductible, the lower the premiums. The combined annual total of the premiums and the maximum contributions for the deductible often is less than the combined premiums and deductible you would pay for a lower-deductible policy. You may be able to negotiate discounts because you're paying cash for routine expenses, and you have your choice of doctors.

How would my contributions earn money? It varies from plan to plan, but generally you invest MSA funds in money markets initially. Once you meet required account minimums, you can invest in mutual funds. Some experts feel that because you may need MSA money at any time, you should stick to money markets. Others suggest that you keep one to three years' de-ductible amount in money markets and invest any excess in mutual funds.

In theory, if your medical expenses remain low, you could build what amounts to an additional retirement nest egg to supplement your other retirement accounts and Social Security. (You can't contribute to an MSA after you turn 65.)

Who should consider an MSA? If you qualify, you should consider one. These plans are especially attractive to those with good health and the money to fund the account.

What if the MSA program is not extended after 2003? Existing MSAs will be allowed to continue, but no new accounts may be opened.