What is an MSA?

In general, an MSA is a trust or custodial account created exclusively for the benefit of the account holder and is subject to rules similar to those that apply to individual retirement arrangements (IRAs). As discussed below, contributions to, and distributions from, MSAs receive favorable federal income tax treatment and the funds in an MSA are not subject to federal income tax.

Who is Eligible for to Benefit Under MSAs?

MSAs are available to employees covered under a "high deductible" plan of a small employer and to certain self-employed individuals. A small employer is one that employs, on average, no more than 50 employees during either the immediately preceding or the second preceding year. For an employee of an eligible employer to be eligible to make MSA contributions (or have employer contributions made on his or her behalf), the employee must be covered under an employer-sponsored "high deductible" health plan and must not be covered under any other health plan, other than one providing certain permitted coverage. In the case of an employee, contributions can be made to an MSA either by the individual or by his or her employer. However, an individual cannot contribute to an MSA for a year if any employer contributions are made to an MSA on his or her behalf for that year. Similarly, to be able to contribute to an MSA, a self-employed individual must be covered under a high deductible health plan and no other health plan, other than one that provides certain permitted coverage. What Happens if an Employer With an MSA Plan Ceases to be a Qualifying Small Employer? If a small employer with an MSA plan ceases to be a small employer, then the employer and its employees can continue to contribute to MSAs, including contributions for new employees and employees that did not previously have MSAs, until the year after the first year in which the employer has more than 200 employees. After that, employees who had MSAs can continue to contribute (or have contributions made on their behalf) even if the employer has more than 200 employees.

What is a "High Deductible" Plan?

A "high deductible plan" generally is a health plan with an annual deductible of between $1,500 and $2,250 for individual coverage and between $3,000 and $4,500 for family coverage. Also, the maximum out-of-pocket expenses with respect to allowed costs, including the deductible, must not exceed $3,000 for individual coverage and $5,500 for family coverage. After 1998, these dollar amounts are indexed for inflation.

How Are Contributions to an MSA Taxed?

Contributions by individuals to an MSA are deductible, within limits, "above the line," i.e., in computing adjusted gross income (AGI) for federal income tax purposes. Employer contributions are excludable from employees' gross income within the same limits, except that the exclusion does not apply to contributions made through a cafeteria plan. Earnings on amounts in an MSA are not currently taxable, nor are distributions from an MSA that are used to pay medical expenses. What Are the Limits on Deductibility of MSA Contributions? For self-employed individuals, the deduction for MSA contributions cannot exceed the individual's earned income from the trade or business which sponsors the high deductible plan. For employees, the deduction cannot exceed the individual's compensation from the employer sponsoring the high deductible plan in which he or participates. The maximum annual contribution to an MSA for a year is 65% of the deductible under the high deductible plan in the case of individual coverage and 75% of the deductible in the case of family coverage.

How Are Distributions from an MSA Taxed?

Distributions from an MSA to pay the medical expenses of the individual and his or her spouse or dependents generally are excludable from income. However, in any year for which a contribution is made to an MSA, withdrawals from an MSA maintained by that individual are excludable only if the individual for whom the expenses were incurred was eligible to make an MSA contribution when the expenses were incurred. Distributions that are not used to pay medical expenses are subject to income tax. Such distributions also are subject to an additional 15% penalty tax unless made after age 65, or on account of death or disability.

When May MSAs Be Established?

MSAs only may be established between 1997 and 2000. After December 31, 2000, no new contributions may be made to MSAs except by or on behalf of individuals who previously had MSA contributions and employees who are employed by a participating employer. Self-employed individuals who made contributions to MSAs during the period 1997-2000 also may continue to make contributions after 2000. I hope the foregoing has given you a general idea about the potential tax-saving benefits of MSAs.