MSA and HSA Ins and Outs
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Now for the "outs," or how money can be withdrawn from these accounts.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?