Save for health care costs and retirement with an MSA

by Allen N. Jones

for the Business Journal

In a survey of 500 small businesses earlier this year, Dun & Bradstreet found that health insurance costs continue to skyrocket, forcing business owners to seek new alternatives. About half of the business owners responding said their health insurance premiums had increased this year, with an average increase of 13 percent over last year.

When asked what steps they had taken to deal with the increasing cost of health care, business owners most frequently said they shopped for a new insurance carrier. But the second most common response to rising costs was medical savings accounts (MSAs).

More than a third (34 percent) of those responding to the survey said they had established an MSA, a tax-advantaged account that has the potential to lower a business owner's health costs, while providing an important benefit option to his or her employees.

MSAs appeal to a wide range of individuals and businesses who are looking for a way to lower their health care costs. Across the country, four types of individuals or entities have shown the greatest interest:

?Self-employed people;

?Owners of businesses with 50 or fewer employees;

?Doctors, lawyers, accountants and others in professional partnerships who are treated as self employed; and

?National organizations and affinity groups with qualifying members.

The many advantages of MSAs

MSAs allow eligible individuals and businesses to pay for qualified health-care expenses with tax-deductible or pre-tax dollars set aside in tax-favored accounts. They are linked to insurance plans that carry high deductibles, which generally lowers the cost of premiums.

An MSA is attractive to individuals and small businesses for a number of reasons:

It carries many tax advantages. Contributions to an MSA offer an immediate tax benefit for small-business employees they are made with pre-tax dollars. Any amount contributed by an employer on behalf of employees is excludable from income and wages for federal payroll tax purposes. Contributions made by individuals are deductible from income for federal tax purposes, similar to an IRA.

Tax deferral is another big advantage. In the MSA, contributions are invested at the accountholder's discretion and any earnings on assets in the account are tax deferred. Tax deferral can make a significant difference in the compounded growth on an MSA just as it can in a tax-deferred IRA or 401(k) plan.

Perhaps most importantly, distributions from an NISA are generally tax-free if used to pay for qualifying medical expenses not covered by your health insurance policy, such as vision care, medical and dental exams, ambulance care, emergency treatment, lab tests, prescriptions, hearing aids or wellness programs.

You direct your MSA investments. Contributions to an MSA are applied at the accountholder's discretion to the investments offered within the account. Depending on the MSA you choose, you may be able to choose from among stocks, bonds, mutual funds or money market mutual funds. Any funds not used during the year remain invested in the account, where they can continue to grow tax-deferred and are carried over to the following years.

An MSA can cover long-term health care expenses. One qualifying purpose of MSA distributions is for the purchase of long-term health care insurance coverage. An MSA can help you plan for your own long-term care, or for the care of an elderly parent or relative.

It can supplement your retirement savings. If good health enables you to preserve the assets in your MSA, you may eventually use them to supplement other retirement income.

Unlike a flexible spending account, amounts in an MSA that are not used in any year can be carried over into subsequent years. After age 65, or the age that you are eligible to receive Medicare, you can take withdrawals for any purpose. Distributions for qualifying medical costs continue to be free of federal income taxes. Distributions for non-medical purposes will be subject to ordinary income tax, but not the 15 percent excise tax that is assessed in addition to income taxes on non-medical distributions taken before age 65 (this penalty is not applied if the account holder dies or becomes disabled).

During the year, you can choose to use funds other than those in your MSA to cover medical costs. In this way, you can allow assets in your MSA to continue to accumulate, tax-deferred, until you need them in your retirement years.

An MSA is portable. If you start your own business or change jobs and are still eligible to participate in an MSA, you can transfer your current MSA. Your assets can remain invested without interruption and you can continue to enjoy the account's benefits.

Setting up an MSA

Before you open an MSA, you must purchase a high-deductible, MSA-qualified health insurance plan from an insurance provider. For individual policies, this means a policy with a deductible that falls within the range of $1,500 to $2,250 and limits out-of-pocket expenses to a maximum of $3,000.

For families, the policy must have a deductible between $3,000 and $4,500, and must limit out-of-pocket expenses to $5,500.

To be eligible to open an MSA account, you cannot participate in any other health insurance plan, such as a group policy or a spouse's plan. You can, however, continue to purchase certain other types of health insurance, such as disability, dental, vision care, Medicare supplemental insurance, auto liability insurance with medical coverage or workers' compensation.

Once you have purchased an MSA-compatible health insurance policy, an MSA must be established at a financial or insurance institution that offers these accounts. The maximum annual amount you can contribute to an MSA is based on a percentage of your health-insurance plan deductible.

As of 1998, an individual can contribute up to 65 percent of the deductible, or a maximum of $1,462.50, if the policyholder is covered for the entire year. For family coverage, you can contribute up to 75 percent of the deductible, or a maximum of $3,375, if coverage extends for the whole year.

If you are self-employed, you can receive the tax deduction for contributions in addition to the partial deduction permitted for health-insurance premiums for high-deductible health plans. For 1998, this partial deduction amounts to 45 percent of the premium paid.

Plan with an MSA

MSAs present a tax-advantaged opportunity to meet both your health care and retirement needs, while you reduce your taxable income today. Talk with your financial consultant about how an MSA can help you maintain both your physical and fiscal well being.

Survey data from Dun Bradstreet's "Small Business 1998 Report on Employee Issues,"published June 23, 1998 by Dun Bradstreet, a company of the Dun Bradstreet Corporation.

(Allen N. Jones is senior vice president and director of the Merrill Lynch Private Client Marketing Group.)

INSET CAPTION:

To be eligible to open an MSA account, you cannot participate in any other health-insurance plan, such as a group policy or a spouse's plan.

INSET CAPTION:

Depending on the MSA you choose, you may be able to choose from among stocks, bonds, mutual funds or money market mutual funds.[[In-content Ad]]