Congress launched a four-year medical savings account (MSA) pilot program in 1997 for the self-employed and for employees of small businesses (50 employees or less) that offer a high deductible health insurance plan. To date, the experiment has been something of a bust. Congress authorized the establishment of up to 750,000 MSAs, but according to the Internal Revenue Service, less than 50,000 are in place. A fight is on in Congress to extend the experiment and loosen MSA restrictions so more people will use them. Regardless of whether the program is extended, qualified people have until December 31, 2000, to open an MSA and keep it, since existing MSAs will be allowed to continue.

An MSA might be called an IRA for medical bills. Basically, you take out a health insurance policy with a high deductible. For 2000, the deductible must be at least $1,550 for individuals but no more than $2,350, and for family policies the minimum and maximums are $3,100 and $4,650. In addition, out-of-pocket expenses, which would include such things as co-pays (but not health insurance premiums), cannot exceed $3,100 a year for individuals under the plan and $5,700 for families.

To help pay for these out-of-pocket expenses, the participant makes contributions to the medical savings account. Accounts can be opened through insurance companies offering the medical policy, through a bank or through other qualified institutions which generally is anyone who can establish an individual retirement account. However, as the debate over the MSAs has noted, many financial institutions don’t offer MSAs, so your choices are somewhat limited.

The maximum annual contribution to an MSA is 65 percent of the deductible for individuals or 75 percent of the deductible for families. Thus, the maximum you can put away in 2000 is $1,528 for individuals and $3,488 for families. Money withdrawn to pay for qualified medical expenses such as co-pays and deductibles is not taxed. Money taken out before age 65 to pay for nonmedical expenses (or because of death or disability) is taxed at regular income tax rates and is also hit with a 15-percent penalty. Money withdrawn for nonmedical needs at age 65 or later faces only the person’s regular income tax liability.

MSAs offer two tax advantages. First, contributions are tax deductible, so in effect the federal government is helping to underwrite your medical expenses. Some states also allow you to take a tax deduction.[Boomber, 83] There is no phase-out, either, for higher-income individuals. Contributions by the employer—the employer and the employee can’t contribute in the same year—don’t count toward the employee’s taxable income or FICA (employment) taxes.

Earnings on the contributions also receive tax breaks. They are tax free if the earnings eventually go toward qualified medical expenses and they grow tax-deferred if the money remains in the account until age 65.

How the money is invested depends in part on who you open the MSA with and the amount you have in the account. For some accounts, you might earn interest as low as two percent, to up around five percent. Some MSAs allow you to invest in stocks, bonds and mutual funds, either after you accumulate a minimum amount, or even from the get go. A 1997 study by the National Bureau of Economic Research estimated that half of all MSA participants would use only 30 percent of their contributions to pay for medical expenses. The remaining 70 percent would grow untouched in the accounts. For healthy MSA participants, particularly high income individuals who have maxed out their contributions to regular retirement accounts, an MSA account essentially serves as a supplemental vehicle for retirement.

Here is where financial planners advise caution. Funds in an MSA may need to be tapped virtually without warning for medical needs. Investing all or most of your funds in stocks or bonds raises the possibility of having to sell some of them during a bear market in order to pay for medical expenses. Some financial planners recommend accumulating at least two year’s worth of potential out-of-pocket expenses in cash equivalents, such as money markets, before you begin venturing into riskier investments aimed for retirement.

July 2000— This column is produced by the Financial Planning Association, the membership organization for the financial planning community.