From the February 1999 issue of Entrepreneur

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 suffering from health-care shock brought on by yearly insurance premium hikes. In his search for an alternative way to pay for health coverage, 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 the wheel,' says Stewart. The company made the switch about eight months ago, and Stewart says everyone is especially happy with the tax and savings benefits MSAs provide. The premiums FJR pays to the insurance companies for MSAs are less than what it paid for traditional medical insurance, and Stewart believes his employees are getting more out of the plan.


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

Expanding The Options

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

The change in MSAs was brought about by the passage of the Health Insurance Portability and Accountability Act (HIPAA) of 1996. Under HIPAA, the federal government started a four-year MSA demonstration program for small-business owners with 50 or fewer employees and for self-employed individuals without health coverage. The program's goal? To determine whether MSAs provide an effective way to fund health coverage for these two groups, which often find themselves priced out of the traditional health-care market.

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

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

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

Reaping The Benefits

MSAs come with two components. Those who qualify purchase a high-deductible health insurance policy with an annual deductible of between $1,500 and $2,250. For family policies, the deductible must be between $3,000 and $4,500. Insurance carriers offering MSA policies also generally either provide an indemnity insurance product that pays a percentage of each claim or offer membership in a preferred provider organization that offers lower premium costs if policy holders stick to certain physician networks and hospitals.

The small-business employer or self-employed individual makes monthly contributions to the MSA accounts. Under the law, however, employers and employees can't both contribute. Contributions to the account are deductible from federal income taxes and earn interest on a tax-deferred basis. In addition, according to the National Center for Policy Analysis, a research organization that helped launch the MSA concept, 18 states have made MSA contributions exempt from state income taxes. Contributions to individual accounts can add up to a maximum of 65 percent of their insurance deductibles each year, or 75 percent for family coverage.

During the year, funds can be withdrawn tax-free to pay for qualifying medical expenses. Insurance companies and banks pay a fixed interest rate of about 4.5 to 5.5 percent on the money in the MSA.

At the end of the year, unspent funds can remain in the account and continue earning interest or be withdrawn and applied to nonmedical expenses. But you'll have to pay income taxes and a 15 percent penalty on the money withdrawn. Individuals over 65 or those who become disabled are only subject to standard income taxes on 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-percent deductible. With traditional insurance, uncovered expenses can be deducted only if they exceed 7.5 percent of an individual's adjusted gross income.

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

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 each individual.

Mixed Reviews

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

Part of the problem is that the insurance industry "has not done a great job in promoting and advertising MSAs,' says Jack 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-deductible health insurance policies also presents a challenge. High-deductible policies cost less than low-deductible policies, so insurance agents have little incentive to sell these less-profitable high-deductible health policies, he says.

The short-term nature of the program is another factor. Angie Hunter, director of federal affairs for the Council for Affordable Health Insurance, says some insurance carriers may be reluctant to put a lot of money into developing a product if it's part of a demonstration program that will only last a few years.

Even so, MSAs continue to do well with the self-employed, such as those in rural Elkader, Iowa, says insurance agent Tom Gifford. He and his father own and operate the Gifford Insurance Agency in this town of 1,500 people. "We have written about 60 MSAs this past 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 send all the premiums to the insurance company, we're reaping the benefits of sending only half and saving the other half."

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

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

What's Ahead?

The Patient Protection Act of 1998 (H.R. 4250) passed by the House addressed some of the drawbacks of the current MSA program. That measure proposed lowering deductibles on individual high-deductible policies from $1,500 to $1,000. But the Senate's version of the bill, which would have also lifted the 15 percent penalty for nonmedical withdrawal as long as the annual deductible was covered, didn't pass.

Congressional backers of MSAs are expected to continue to push for improvements in the MSA project. The new Congress will revisit the defeated bill's provisions and discuss other changes, such as lifting the size requirement businesses must meet to offer the plans. If MSAs were open to everybody, "That would spur more interest in them," Gifford believes. In the meantime, the current program is expected to gain additional converts. And, in 10 years' time, Strayer predicts, "Every health plan will have an MSA attached to it."

Next Step

There are a number of insurance carriers offering MSAs with an insurance 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, IA 52043, (319) 245-1360