An Ounce Of Prevention 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 sufferingfrom health-care shock brought on by yearly insurance premiumhikes. In his search for an alternative way to pay for healthcoverage, 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 thewheel,' says Stewart. The company made the switch abouteight months ago, and Stewart says everyone is especially happywith the tax and savings benefits MSAs provide. The premiums FJRpays to the insurance companies for MSAs are less than what it paidfor traditional medical insurance, and Stewart believes hisemployees are getting more out of the plan.

Joan Szabo is a writer in Great Falls, Virginia, who hasreported on tax issues for more than 12 years.

Expanding The Options

FJR Manufacturing is just one of thousands of small businessesthat recently opted for this nontraditional approach to healthcoverage. While MSAs have been around since the early 1990s, theyweren't offered with federal tax benefits until 1997.

The change in MSAs was brought about by the passage of theHealth Insurance Portability and Accountability Act (HIPAA) of1996. Under HIPAA, the federal government started a four-year MSAdemonstration program for small-business owners with 50 or feweremployees and for self-employed individuals without healthcoverage. The program's goal? To determine whether MSAs providean effective way to fund health coverage for these two groups,which often find themselves priced out of the traditionalhealth-care market.

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

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

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

Reaping The Benefits

MSAs come with two components. Those who qualify purchase ahigh-deductible health insurance policy with an annual deductibleof between $1,500 and $2,250. For family policies, the deductiblemust be between $3,000 and $4,500. Insurance carriers offering MSApolicies also generally either provide an indemnity insuranceproduct that pays a percentage of each claim or offer membership ina preferred provider organization that offers lower premium costsif policy holders stick to certain physician networks andhospitals.

The small-business employer or self-employed individual makesmonthly contributions to the MSA accounts. Under the law, however,employers and employees can't both contribute. Contributions tothe account are deductible from federal income taxes and earninterest on a tax-deferred basis. In addition, according to theNational Center for Policy Analysis, a research organization thathelped launch the MSA concept, 18 states have made MSAcontributions exempt from state income taxes. Contributions toindividual accounts can add up to a maximum of 65 percent of theirinsurance deductibles each year, or 75 percent for familycoverage.

During the year, funds can be withdrawn tax-free to pay forqualifying medical expenses. Insurance companies and banks pay afixed interest rate of about 4.5 to 5.5 percent on the money in theMSA.

At the end of the year, unspent funds can remain in the accountand continue earning interest or be withdrawn and applied tononmedical expenses. But you'll have to pay income taxes and a15 percent penalty on the money withdrawn. Individuals over 65 orthose who become disabled are only subject to standard income taxeson 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-percentdeductible. With traditional insurance, uncovered expenses can bededucted only if they exceed 7.5 percent of an individual'sadjusted gross income.

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

The maximum benefit on many of these high-deductible policies is$2 million, although some policy benefits are closer to $1 million.That amount covers a lifetime's worth of benefits for eachindividual.

Mixed Reviews

Even though they offer attractive tax benefits, MSAs are off toa slow start; fewer accounts have been started than was anticipatedby Washington. The law allows 750,000 self-employed andsmall-business owners and their employees to open MSAs betweenJanuary 1, 1997, and December 31, 2000. As of July 1998, the IRSreported only 54,702 taxpayers had opened MSAs. Of these, 17,688previously did not have health insurance.

Part of the problem is that the insurance industry "has notdone a great job in promoting and advertising MSAs,' saysJack Strayer, vice president of external affairs at the Washington,DC, office of the National Center for Policy Analysis.

The fact that MSAs work in conjunction with high-deductiblehealth insurance policies also presents a challenge.High-deductible policies cost less than low-deductible policies, soinsurance agents have little incentive to sell theseless-profitable high-deductible health policies, he says.

The short-term nature of the program is another factor. AngieHunter, director of federal affairs for the Council for AffordableHealth Insurance, says some insurance carriers may be reluctant toput a lot of money into developing a product if it's part of ademonstration program that will only last a few years.

Even so, MSAs continue to do well with the self-employed, suchas those in rural Elkader, Iowa, says insurance agent Tom Gifford.He and his father own and operate the Gifford Insurance Agency inthis town of 1,500 people. "We have written about 60 MSAs thispast year," he says. As a self-employed individual, Tom, 29,started a plan for himself, his wife and their 1-year-old daughter.The Giffords have few health-care expenses. "Rather than sendall the premiums to the insurance company, we're reaping thebenefits of sending only half and saving the other half."

If you decide to shop for an MSA, proceed with caution. It'simportant to know what your premiums will cost. In some cases, ahigh-deductible policy may not be much cheaper than a goodmanaged-care plan, say health industry analysts.

A reasonably priced health premium combined with a savings planshould equal about what you'd pay for a traditional healthplan, says Gifford. Be sure you understand which expenditures applyto your policy's deductible and out-of-pocket provisions. Andremember, even if the program is discontinued in 2000, you'llbe able to keep your MSA active.

What's Ahead?

The Patient Protection Act of 1998 (H.R. 4250) passed by theHouse addressed some of the drawbacks of the current MSA program.That measure proposed lowering deductibles on individualhigh-deductible policies from $1,500 to $1,000. But theSenate's version of the bill, which would have also lifted the15 percent penalty for nonmedical withdrawal as long as the annualdeductible was covered, didn't pass.

Congressional backers of MSAs are expected to continue to pushfor improvements in the MSA project. The new Congress will revisitthe defeated bill's provisions and discuss other changes, suchas lifting the size requirement businesses must meet to offer theplans. If MSAs were open to everybody, "That would spur moreinterest in them," Gifford believes. In the meantime, thecurrent program is expected to gain additional converts. And, in 10years' time, Strayer predicts, "Every health plan willhave an MSA attached to it."

Next Step

There are a number of insurance carriers offering MSAs with aninsurance policy and savings account. Here are some of them:

• Golden Rule Insurance Company, (888) 672-0829

• Mutual of Omaha, (800) 775-6000

• Fortis Health, (888) 846-3672

Contact Sources

Council for Affordable Health Insurance, http://www.cahi.com

Gifford Insurance Agency, 123 N. Main St., Elkader, IA52043, (319) 245-1360