Taking the taxes out of health care - medical savings accounts

Nation's Business, Dec, 1996 by James Worsham

Employees at small firms will soon be able to take part in a national experiment medical savings accounts.

The self-employed and workers at companies with fewer than 50 employees can sign up for tax-free medical savings accounts under a federal pilot program that begins Jan. 1.

The accounts, known as MSAs, work like retirement savings plans. Employees or their employers will make tax-free contributions to an account similar to an individual retirement account (IRA). The MSA is earmarked for use by the participating individual to pay medical bills not covered by insurance.

The pilot program's rules spell out who can sign up, require that participants have health insurance that meets certain criteria, and tightly govern the use of the accounts for paying medical bills.

The required insurance, whether purchased by the individual or by the employer, must have high annual deductibles--at least $1,500 for an individual policy and at least $3,000 for a family policy--but will cost significantly less than current policies with $250 or even $500 deductibles.

The pilot program for testing the MSA concept was included in a federal health-insurance-reform law enacted last summer. Under the law, up to 750,000 currently insured individuals, couples, and families will be allowed to set up MSAs.

Congress will use the pilot program as a basis for either expanding the MSA concept beyond the end of 2000, the fourth year of the pilot program, or abandoning it. Even if the MSA concept is not expanded, however, those who participate in the pilot program can keep their accounts indefinitely as long as they work for companies with fewer than 50 workers or remain self-employed.

The most outspoken champions of MSAs have been conservatives who oppose a greater government role in health care. John Goodman, president of the National Center for Policy Analysis, a Dallas organization that was one of the earliest MSA advocates, says the accounts will encourage individuals to shop around for medical services and obtain the lowest prices.

"The MSA empowers the employee and the employee's family," he says. But while Goodman feels the program is "a step in the right direction," he's skeptical that the pilot program will provide any useful information about consumers, medical costs, or the way health-care costs are met.

MSA critics, among them Clinton administration officials and many Democrats in Congress, argue that MSAs will help only individuals who have few health problems and who can afford to put money into the accounts. People who are poor and sick and who don't have MSAs, the critics say, would face higher premiums as the wealthier and the healthier migrated to MSAs, leaving fewer people among whom to spread the rising cost of moreconventional insurance plans.

In addition, some observers maintain, people with MSAs could become disinclined to seek medical help when it's needed. "The MSAs may deter people from going to the doctor for a checkup just to save money," says Paul Fronstin, a research associate at the Employee Benefit Research Institute, in Washington, D.C.

Under the MSA plan approved by

Congress, there will be no federal tax on funds contributed to an account or on earnings on the funds. Nor will there be any tax on funds withdrawn as long as they are used to pay qualified medical expenses. Funds not withdrawn can accumulate tax-free over the years until needed.

Money withdrawn for nonmedical purposes will be taxed as income and subject to a 15 percent penalty if the individual is under 65. There will be no penalty for nonmedical withdrawals for people 65 or older.

Workers will be able to sign up for an MSA plan with their employer if the employer offers the plan in connection with a high-deductible insurance policy. If the employer offers a high-deductible policy but doesn't want to offer MSAs, employees can sign up for the accounts on their own as long as they also have the health insurance through their employer. But if the employer doesn't offer the high-deductible policy, the employee will not be eligible for the MSA program.

The self-employed may buy a high-deductible insurance plan and start an MSA with the insurance company itself or at a bank, credit union, or savings and loan.

As with IRAs, money in an MSA may be invested in a variety of ways, including stocks or bonds.

The federal government will receive periodic reports from insurers and financial institutions on the number of MSAs set up. Individuals must report contributions and withdrawals on their annual income-tax forms. Employers who contribute to employee MSAs must report the amounts when filing their taxes, and the amounts of their contributions cannot vary among employees.

Once the overall 750,000 cap is reached, no new accounts can be set up. The first count will be taken April 30, 1997, and if the number exceeds the 375,000 cap for the first year, enrollment will be halted on Sept. 1, 1997. Even if the total count exceeds the cap, however, no one will be terminated from the program as long as he or she is enrolled by Sept. 1 and continues to qualify under the rules.