Medical and Health Savings Accounts

High-deductible policies have lower premiums than low-deductible plans.
High-deductible policies have lower premiums than low-deductible plans.

If you are one of the lucky Americans who has health insurance, you are also most likely one of the many who are confused by your health insurance options. Do you know what a Medical Savings Account (MSA) is? Did you know it's different from a Health Savings Account (HSA)? And what does either of them have to do with something called consumer-driven health care? You're about to find out.

First we'll discuss the idea of consumer-driven health care. This type of health care involves patients who have a high-deductible health insurance policy and either an HSA or an MSA. The idea behind it is that you pay for your own routine health care expenses with funds you've accrued in your HSA or MSA. Meanwhile, the high-deductible health insurance policy is used as more of a safety net -- it protects you from any catastrophic medical expenses. These types of insurance policies tend to have a dramatically lower monthly premium than low-deductible health insurance plans do.

Why is this a good idea? There are arguments for both sides, of course. Supporters have a few main arguments:

  • Consumer-driven health care will cost you less over the long run because of the lower premiums and the tax breaks you get for having an HSA or MSA. This could be true if you're extremely healthy or if you're extremely sick. If you're healthy, you don't have many health expenses, you're covered in case of catastrophe, you have low monthly payments, and you can build up the money in a tax-friendly HSA or MSA. If you're extremely sick, you'll probably have high monthly expenses for medications and doctor's visits. With an HSA or MSA, you would quickly meet your deductible, and the insurance would cover expenses for the remainder of the year.
  • If people can determine how and where their health care money is spent, it would booster competition in the health care system, which, in theory, would lower health care costs.
  • HSAs help deter abuse of benefits. If you're paying for a doctor's visit instead of having a $25 copay, you might make fewer unnecessary doctor's appointments.

The arguments against this type of health care include the fact that health care isn't like other markets, in which services are clear and prices are known. If you have an HSA, you could just as easily choose to forgo a needed medical procedure because of the costs. In addition, many consumers are overwhelmed by the amount of health care information. They question the quality of the information needed to make the best decision for their health. So many critics argue that lower-income, less-educated consumers are not as likely to benefit from this kind of plan.

Next, we'll discuss these savings accounts.

Medical and Health Savings Accounts History

Agency: Dreamstime You can make tax-deferred deposits into an MSA or HSA that will be used for qualifed medical expenses.
Agency: Dreamstime You can make tax-deferred deposits into an MSA or HSA that will be used for qualifed medical expenses.

On the surface, a medical savings account (MSA) and a health savings account (HSA) are the same. They are both savings accounts into which you can make tax-deferred deposits that will then be used for qualified medical expenses. You have to use both in conjunction with a high-deductible health plan. In addition, you can invest the funds in both types of accounts, and any unused money will remain in the account.

Despite this shared, and simplified, definition, these savings accounts do have differences -- including who qualifies for each type, who is authorized to add money to the account and how much money can be added. But before we get into all those details, let's find out how each of these accounts got their start.

The MSA is the older of the two types of savings accounts. It was created in the 1990s

when health care analysts expressed concern about "overinsurance." The analysts feared that patients were overusing their medical benefits on trivial medical issues, which was causing health care costs to skyrocket. They believed that if patients

paid for their own health care, health care costs, along with "overinsurance," would decrease. Think tanks and insurance companies began to push for a law creating tax-free savings accounts, or MSAs, which would allow people to save for their own health care expenses. A federal MSA law didn't pass in the 1990s, but Congress passed an MSA pilot in 1996, and some individual states also passed their own MSA legislation. More than 25 states had MSA legislation by 1998.

The reign of the MSA was short-lived, though -- HSAs were created in 2003. MSAs are still available, but there are only a few financial institutions that will open new MSA accounts. Today, they are called Archer MSAs, after Congressman Bill Archer of Texas, who sponsored the MSA pilot in 1996.

In 2003, the HSA was born when the Medicare Prescription Drug, Improvement, and Modernization Act was signed into law by President Bush. Supporters touted HSAs as an improvement on MSAs.

Next, we'll discuss how these two types of accounts work. Let's start with the "ins," or how things get deposited into the accounts.

MSA and HSA Ins and Outs

Agency: Dreamstime MSAs and HSAs could prevent your wallet from being squeezed in the event of a catastrophe.
Agency: Dreamstime MSAs and HSAs could prevent your wallet from being squeezed in the event of a catastrophe.
©

To open an MSA or HSA, you need a high-deductible health plan (HDHP). Once you've done that, you can make a deposit into an MSA or HSA on a pretax basis through your employer. If you don't make the deposit through your employer, the contribution is post-tax, and you can use it to decrease gross taxable income on the following year's income tax form.

The IRS limits the amount you can put into each type of account every year. Any money you deposit above these limits is considered excessive and is not tax-deductible. Once you deposit the money, however, it is your property -- it stays in the account. Also, if you leave your employer, or even if you end your participation in an HDHP, you still have the account.

You can invest the money in an MSA or HSA like you'd invest funds in an individual retirement account (IRA). Any earnings from these investments are sheltered from taxation. Unlike in an IRA, this money can remained sheltered even after you withdraw it -- if it's used for legitimate medical expenses. However, you can't roll HSAs and MSAs into an IRA or a 401(k). In most circumstances, you can't roll 401(k)s and IRAs into an HSA or MSA, either.

Now for the "outs," or how money can be withdrawn from these accounts. ­­­­­

­Taking money out of an HSA o­r MSA is relatively easy -- it's just like a normal checking account. You can use a debit card, checks or reimbursement forms, and all funds used for qualified medical expenses are not taxed. But if you withdraw funds for use beyond medical necessity, they will be subject to income tax plus an additional taxation for early withdrawal, depending on the type of account. An exception to this early withdrawal taxation rule applies to those who are 65 and older, or those who we­re considered disabled when the withdrawal occurred. The IRS posts a list of qualified expenses -- which include over-the-counter medications, first aid supplies and chiropractor visits [source: IRS]. ­­­­

­Another attractive aspect of these types of accounts is that if your medical expenses remain low over a period of time and you're still making contributions to the account, your account can accumulate a good amount of assets. You can spend the money tax-free on health care or on a tax-deferred basis in retirement. You can also reinvest them in higher-growth products. ­

­What happens if you die with money in your MSA or HSA? The beneficiary you named will receive all remaining funds -- and if the beneficiary is your spouse, the money is transferred tax-free.

N­ow we know the similarities between these two plans. But what are the differences? ­

MSA and HSA Differences

You and your employer can both contribute to your HSA in the same year.
You and your employer can both contribute to your HSA in the same year.

There are several key differences between a medical savings account (MSA) and a health savings account (HSA).

Who Qualifies:

We know that a high-deductible health care plan is needed for both of these plans, but to open an MSA, there are a few more qualifications. To qualify for an MSA you must be an employee, or spouse of an employee, of a company that employs 50 or fewer people -- or you must be self-employed or a spouse of a self-employed person.

Who Can Give You Money:

If you have an HSA, you can make contributions yourself and receive contributions from your employer (or other generous people) within the same year. If you have an MSA, you can't have contributions from your employer and yourself in the same year.

How Much Money You Can Put In:

The IRS maximum for yearly HSA deposits in 2007 is $2,850 for individual plans and $5,650 for family plans. If you are 55 or older, you can contribute an additional $700. The MSA contribution limit is set by a percentage of your annual deductible and by your income. If you have an MSA, you can't contribute more than you earned that year. And no additional contributions can be made based on age.

How Much Early Withdrawal Will Cost You:

In both plans, you will be subject to income tax. There is also additional taxation for early withdrawal if you take out money for something besides medical expenses. This additional taxation varies with the type of spending account -- with MSAs, it's 15 percent additional tax, and for HSAs, it's 10 percent.

For more information about MSAs and HSAs, check out the links on the next page.

­­­

Related HowStuffWorks Articles

More Great Links

Sources

  • AARP: Medical Savings Accounts. http://www.aarp.org/research/health/carefinancing/aresearch-import-683-FS80.html
  • HSA vs HRA vs MSA vs FSA. http://rams.fremont2.k12.wy.us/districtoffice/DOMain/hsa_compare_chart.pdf
  • Mayo Clinic: Is a HSA Right for You? http://www.mayoclinic.com/print/health-savings-accounts/GA00053/METHOD=print
  • IRS: Health Savings Accounts & Other Tax-Favored Health Plans. http://www.irs.gov/pub/irs-pdf/p969.pdf
  • JAMA: Health Insurance, The Basics. http://jama.ama-assn.org/cgi/content/full/297/10/1154