Good medicine: medical savings accounts offer tax advantages and more - but you'd better rush to get them

Entrepreneur, Dec, 1996 by Stephen Barlas

The Health Insurance market for entrepreneurs will take on a hurly-burly Wild West look come January 1, 1997, when The Health Insurance Portability and Accountability Act takes effect. That's when insurance companies, as well as banks and financial services firms - and who knows who else - will start offering medical savings accounts (MSAs) on a nationwide scale.

MSAs allow individuals with high-deductible health insurance plans to set aside money for out-of-pocket medical expenses and gain advantages on federal taxes. They have existed on the state level for some time: Eighteen states already allow a deduction on state income taxes for MSAs, according to Jack Strayer, director of federal affairs for The Council for Affordable Health Insurance, a trade association.

The health insurance reform bill signed by President Clinton this summer - dubbed Kassebaum-Kennedy for its two Senate sponsors - authorized federal income tax deductions for MSAs for the first time under a four-year pilot program. These MSAs will be restricted to sole proprietors and companies with fewer than 50 employees.

That's not the only restriction, however; Congress is allowing only 750,000 MSAs to be established during the four-year trial period, with the exception that all MSAs established in the first four months of the program will be honored indefinitely (even if this number surpasses the 750,000 limit, which is largely expected). Unless Congress acts to extend the program, the availability of MSAs will terminate on December 31, 2000.

"My advice is to move fast," says James Morrison, senior policy advisor to the National Association for the Self-Employed. "The 750,000 cap will be reached in a matter of months."

* TAXING MATTERS

Many self-employed individuals already have health insurance plans. Whether your plan has a high or low deductible, converting to an MSA is likely to bring not only tax benefits but possibly even lower premiums as more and more companies compete to provide MSAs.

No one is quite sure how these policies will be set up, or by whom. "But you can lay odds there are some very busy people trying to figure out how to get to market on this," says Neil Trautwein, manager of healthcare policy for the U.S. Chamber of Commerce.

What we do know is how it will work. Someone who is self-employed might buy a family policy with a deductible of $4,500. Assume premiums are $2,000 a year. Under the new law, starting in 1997, 40 percent of that $2,000 can be written off annually as a health insurance deduction. The amount that can be written off increases in stages, reaching 80 percent in the year 2006.

The next step is to set up an MSA; this could be done through whomever handles your Simplified Employed Pension (SEP), Keogh or company pension plan, or anyone else qualified to do so. The amount you put into the account is pre-tax. You can withdraw a maximum of $3,000 annually (for an individual) and $5,500 (for families) to pay out-of-pocket medical expenses.

MSAs allow you to use the set-aside funds for medical expenses with no tax penalty. For family policies, annual contributions are limited to 75 percent of the plan's deductible (for individuals, it's 65 percent); in the example above, that would be $3,375 (75 percent of $4,500). Deductibles for families must be between $3,000 and $4,500; for individuals, between $1,500 and $2,250. Any money left over at the end of the year can remain in the account for future medical expenses.

The Treasury Department will report to Congress at the end of June 1997 on how many MSAS were set up. The question everyone is asking is: What if, as expected, the number of people interested in establishing MSAs is in the millions? Although those who established accounts in the first four months of the program will be allowed to keep them, what will happen to any others set up afterward is anyone's guess.

* GUARANTEED COVERAGE

While MSAs will be of most value to entrepreneurs who are healthy (because their out-of-pocket medical expenses are lower), the Kassebaum-Kennedy bill is also beneficial to someone with health problems who leaves a corporate job to start a business. Under the bill, if you have a pre-existing medical condition, you cannot be denied an individual (or family) health insurance policy once certain conditions are met.

One of those conditions is that you must pay for a corporate conversion insurance policy for a set period - generally 18 months, but sometimes up to 36 months. Once that policy ends and you have satisfied whatever other conditions your former employer set, you cannot be denied health insurance because of a pre-existing condition.

There's just one catch: Kassebaum-Kennedy sets no limits on what an insurance company can charge for that guaranteed policy. The National Association of Insurance Commissioners says many state legislatures have enacted what are called individual market rating reforms. These require health insurance premiums in the small group market to be within a certain price range.