An ounce of prevention

Entrepreneur, Feb, 1999 by Jean Szabo

The tax benefits of MSAs may boost your immunity against the health-care blues.

Roger Stewart is a true believer in medical savings accounts (MSAs). Stewart, who is president and partner at FJR Manufacturing, a small West Bend, Wisconsin, machinery manufacturer, was suffering from health-care shock brought on by yearly insurance premium hikes. In his search for an alternative way to pay for health coverage, Stewart discovered MSAs.

All the company's partners, as well as its 20 employees, have MSAs now. "I think they're the best thing since the wheel," says Stewart. The company made the switch about eight months ago, and Stewart says everyone is especially happy with the tax and savings benefits MSAs provide. The premiums FJR pays to the insurance companies for MSAs are less than what it paid for traditional medical insurance, and Stewart believes his employees are getting more out of the plan.

EXPANDING THE OPTIONS

FJR Manufacturing is just one of thousands of small businesses that recently opted for this non-traditional approach to health coverage. While MSAs have been around since the early 1990s, they weren't offered with federal tax benefits until 1997.

The change in MSAs was brought about by the passage of the Health Insurance Portability and Accountability Act (HIPAA) of 1996. Under HIPAA, the federal government started a four-year MSA demonstration program for small-business owners with 50 or fewer employees and for self-employed individuals without health coverage. The program's goal? To determine whether MSAs provide an effective way to fund health coverage for these two groups, which often find themselves priced out of the traditional health-care market.

MSA advocates say the accounts effectively control health-care spending by making consumers more aware of what medical care costs. With MSAs, consumers select their own doctors and decide where to spend their money. As a result, supporters say, there's a greater incentive to shop around for the best prices and avoid overutilizing medical services.

That's been true for employees at FJR Manufacturing, says Stewart. "Employee behavior started to change instantly," he says. "They check out prices for health costs. It's their money, and they're very interested in making sure they don't spend it needlessly."

Opponents, however, maintain that MSAs are designed for the healthy and well-heeled. MSAs will drive up the cost of traditional health plans, they argue, because only individuals with low incomes and high medical expenses will remain in traditional plans.

REAPING THE BENEFITS

MSAs come with two components. Those who qualify purchase a high-deductible health insurance policy with an annual deductible of between $1,500 and $2,250. For family policies, the deductible must be between $3,000 and $4,500. Insurance carriers offering MSA policies also generally either provide an indemnity insurance product that pays a percentage of each claim or offer membership in a preferred provider organization that offers lower premium costs if policy holders stick to certain physician networks and hospitals.

The small-business employer or self-employed individual makes monthly contributions to the MSA accounts. Under the law, however, employers and employees can't both contribute. Contributions to the ac- count are deductible from federal income taxes and earn interest on a tax-deferred basis. In addition, according to the National Center for Policy Analysis, a research organization that helped launch the MSA concept, 18 states have made MSA contributions exempt from state income taxes. Contributions to individual accounts can add up to a maximum of 65 percent of their insurance deductibles each year, or 75 percent for family coverage.

During the year, funds can be withdrawn tax-free to pay for qualifying medical expenses. Insurance companies and banks pay a fixed interest rate of about 4.5 to 5.5 percent on the money in the MSA.

At the end of the year, unspent funds can remain in the account and continue earning interest or be withdrawn and applied to nonmedical expenses. But you'll have to pay income taxes and a 15 percent penalty on the money withdrawn. Individuals over 65 or those who become disabled are only subject to standard income taxes on nonmedical withdrawals.

The tax benefits are especially helpful to the self-employed. Contributions to an MSA account are completely tax deductible, making all medical costs not covered by insurance 100-percent deductible. With traditional insurance, uncovered expenses can be deducted only if they exceed 7.5 percent of an individual's adjusted gross income.

If you use all the funds in an MSA account during the year for medical expenses, only the difference between the deductible and the MSA amount needs to be paid before the high-deductible policy is activated. For example, if, as a single individual, you have an MSA of $1,300 and a policy with a deductible of $2,000, you're only responsible for $700 in out-of-pocket expenses before covered medical bills are paid 100-percent by the high-deductible policy.