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Forgotten benefits of medical savings accounts

By T. Michael Regan, CPA

The Health Insurance Affordability and Accountability Act became law in 1996. At that time a much-discussed provision of the act was one that allowed certain small businesses to establish Medical Savings Accounts (MSAs) between 1997 and the year 2000.

What are the benefits of MSAs? First and most obvious is the tax deduction derived from the contribution to the savings account. Then, the funds in the account grow tax-free. Money from the account may be used to pay for a variety of qualified health services in addition to the procedures covered by standard health care policies. Eyeglasses, dental care and long-term care insurance are good examples. Unused funds are carried over from year to year. While there are limitations on the amount contributed to the plan, there is no limit on the earnings or carryover.

MSAs are portable from employer to employer. The funds can even be used to purchase interim hospitalization coverage between jobs. Finally, if the money is not all used by the time the participant reaches 65 years of age, it becomes an additional retirement account. The taxation is similar to that of an IRA and may be withdrawn without penalty.

What are MSAs? Medical Savings Accounts are tax advantaged benefit plans that combine a low-premium, high-deductible health care insurance policy with a savings account. There are limitations, of course. First, the act allowed for no more than 750,000 MSA plans nationally. Second, eligible employers must have 50 or fewer employees. Contributions to the savings account may be made by either the employee or the employer (but not both) and are excluded from the employee’s taxable earnings. Again, there are limitations. Contributions to an employee’s account cannot exceed 65 percent of the deductible for an individual’s policy or 75 percent of the deductible for a family’s policy. Further, the maximum contribution is limited to $1462.50 an individual and $3375 for family coverage.

Who reaps the benefits? Because physicians may be, at any given time, employers, employees and health care providers, they are in a particularly good position to benefit. As an employer, a physician should see direct savings in the form of reduced costs for hospitalization coverage. Essentially, the employer is required to purchase a qualifying policy with a high deductible, similar to catastrophic coverage. The premium reduction should more than pay for the contribution to the savings account. Further, the employer has a lower percentage of the overall benefit cost exposed to the annual inflation in premiums. Although none of us can predict how quickly premiums will rise in future years, the savings should be amplified by the passage of time.

Employees, of course, have the greatest potential return. They are afforded the freedom to choose a doctor in using the money in their savings account. They will see a reduction in their taxable income if they contribute to the MSA out of their wages. Employees who don’t spend the money, can keep it, with some restrictions. The account can be something of a safety net between jobs and an additional retirement plan if things go well. An individual may even take nonqualified withdrawals from the plan. Such withdrawals are subject to both tax and penalty, however.

The physician’s benefit as a provider is more difficult to define but may come in the form of both tangible and intangible rewards. At one time, physicians concerned themselves with the clinical aspect of practicing medicine. Currently they worry about referrals and pre-certifications before seeing the patient, utilization review during the treatment and submitting the proper claim afterwards. In the MSA model, many of the services received by a patient are covered by the MSA account, not an insurance policy. Certainly the physician may be required to abide by a PPO contract regarding fees, but he or she should realize a reduction in the irritants inherent with managed care and in administrative costs. Finally, many proponents feel that MSAs will restore the traditional doctor-patient relationship.

How is a Medical Savings Account Plan established? First, you should try to determine the cost of a plan relative to what you have in place. Your accountant or the potential plan administrator can help you with the calculation.

The second important decision is who will make the contributions: employee or employer? This may be as much a matter of goodwill as of cost. An insurance company or a financial institution must administer the plan. Many people prefer banks or brokerage houses to invest the funds held in the accounts. The employer must then obtain a qualifying health care policy, probably from the financial institution’s list of insurers. Many insurance companies also have financial programs and will offer turnkey plans that include both the insurance and investment services. At that point you will have all of the pieces in place.

There can be some drawbacks to an MSA. Circumstances exist where simply no savings will accrue to the employer. Chronic illness may also destroy the benefits expected by the employee. The probability of either of these conditions occurring can be calculated. Most MSA providers should be able to define the potential savings. Additionally, a number of Internet web sites offer interactive worksheets for the calculation.

An MSA account may only be accessed if the participant remains in a qualified MSA plan. If someone were to move to an employer with no MSA, money in the account could only be withdrawn without penalty after the individual became 65.

Further, companies with rapidly growing employment would have to discontinue the MSA. An employer may start an MSA if it has 50 or fewer employees. It can maintain the plan only until number of employees exceeds 200. Companies growing beyond that point have one year to discontinue the plan. One final downside is that this is still an experimental program. In the year 2000, the Treasury Department will assess the effectiveness and participation of MSAs in conjunction with their impact on Federal revenues.

Why, if MSAs are so wonderful, have so few of the 750,000 slots been filled? Internal Revenue Service statistics indicate that only about 68,000 plans now exist. The reasons are open to speculation. It appears, however, to be mainly a matter of publicity. It has been said that in Medical Savings Account had the same amount of print space as the Roth IRA, we would have seen 750,000 plans in 1997 alone. MSAs do not have the obvious glamour of the Roth. Nor do they have the wholehearted backing of Congress.

There does appear to be a strong case for looking into the potential of a Medical Savings Account Plan for many employers. Both the employer and the employed may be missing significant financial benefits. Neither will know for certain unless they investigate the possibilities.

T. Michael Regan, CPA, is a partner with the accounting firm of Horovitz, Rudoy and Roteman.

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