by Joel M. Blau
Joel M. Blau is president, MEDIQUS Asset Advisors, Inc., an affiliate of AMA Investment Advisors.
The Health Insurance Portability and Accountability Act of 1996 provided a new type of savings account which is designed to help taxpayers pay unreimbursed medical expenses on a tax-advantaged basis. The Medical Savings Account (MSA) is available only when used in conjunction with an employer-sponsored health insurance policy which has a very high deductible. MSAs are available on a test basis until the year 2000. Participation is limited to 750,000 individuals who are self-employed or employed by a business with 50 or fewer employees. Once the 750,000 limit is reached, the IRS will announce a cutoff for new plans.
Employees' contributions to an MSA are deductible from their adjusted gross income. Employer contributions to an MSA are not generally considered taxable income to the employee, but still must be reported on the employees' W-2 form for IRS information purposes only. Earnings on the invested MSA funds also are not subject to current taxation.
The maximum contributions are based on the health insurance policy's annual deductible. For those employees with single coverage, the annual contribution limit is 65 percent of the deductible while family coverage participants are allowed to contribute up to 75 percent of the deductible. In order to eliminate the possibility of excessive contributions, the law placed limits on maximum deductibles for the policies. The maximum deductible for single coverage is $2,250 while the minimum deductible is $1,500. The family coverage maximum deductible is $4,500 with a minimum deductible of $3,000. These limits will be increasing based on inflation factors after 1998.
Distributions from an MSA to pay for qualified medical expenses are generally received tax-free by the participant. To qualify, the payments must be made for unreimbursed expenses that would otherwise qualify for the medical expense itemized deduction. Funds distributed for other purposes are taxed as ordinary income and would incur a 15 percent penalty unless the distribution is made due to death, disability or the MSA owner's attainment of age 65.
The potential tax benefits of MSAs are significant because of the powerful combination of deductible contributions, deferred earnings and tax-free payments for qualified medical expenses. Employees cannot take an itemized deduction for unreimbursed medical expenses. Since that deduction is available only if expenses exceed 7.5 percent of adjusted gross income, many taxpayers never have the ability to take advantage of it.