The Basics
Medical Savings Accounts invest in your health
Recognize yourself in
this picture?
You left your corporate job to set up your own shop a couple of
years ago and spent the first 18 months fretting that you wouldn't be able to pay the
bills. The good news is that the money started rolling in. The bad news is that you've
been using a big chunk of it to replace the benefits package you left behind.
Finding -- and paying
for -- benefits, particularly medical insurance, is the dark side of most successful
one-person businesses. Many people "go bare," as they say in the insurance
industry, taking their chances with no coverage at all. Others opt for the highest
deductible health care policy they can find, reasoning that it will cover them in a
catastrophe. If you are among them, you should be looking carefully at the medical savings
account, a new tax-advantaged health insurance program for self - employed individuals and
workers at businesses with 50 or fewer employees.
An
experiment
Congress
approved medical savings accounts, combined with a high-deductible insurance policy, as a
four-year experiment starting on Jan. 1, 1997. Here's how they work: You get a tax
deduction for money contributed to the account each year. Then you pay your medical
expenses by withdrawing funds from the account. If expenses exceed your insurance policy's
deductible amount, the policy kicks in and pays the additional costs. If you spend less
than the amount you contributed, the difference stays in the account and earns interest.
"For the self-employed business person, this is the best
chance you've had in a long time to take care of yourself," says Lee Tooman,
assistant vice president of Golden Rule Insurance Co. in Lawrenceville, Ill.
Misunderstood
But
Richard Stover, a health care actuary with Buck Consultants in New York, says taxpayers
have not been opening them as quickly as expected. “There's no incentive for a broker
to sell them," Stover says, "and many people still don't understand how they
work."
Also, since this is a test program, there are no guarantees the
government will let the program continue in the long term. Since brokers have little
incentive to sell them, it’s also difficult to find MSAs in every state.
Big businesses have
been using flexible spending accounts -- or FSAs -- for years. But they have not been
available to the self-employed. And the new medical savings accounts have a compelling
advantage: The money is allowed to roll over and build up in the account if you don't
spend it. In contrast, the flexible spending accounts offered by large employers have a
"use-it-or-lose-it" provision. Whatever is not used by the end of the year is
lost to you. And rather than lying dormant in low interest-bearing savings accounts, you
can invest it in mutual funds, stocks or other investment vehicles that typically offer
much higher returns over the long run. Whatever you don't spend can be used to supplement
retirement income.
Rules and limits
The
government set some rules for the MSA accounts. There is a range for the deductible on the
insurance policies: $1,500 to $2,250 a year for an individual; $3,000 to $4,500 a year for
a family. Above that amount, the insurance program might cover 100% of expenses. Or it can
provide for some type of co-payment by participants, say 20% of all covered expenses in
excess of the deductible. The government also set limits on total out-of-pocket medical
expenses (deductibles plus co-payments) with a maximum of $3,000 for a single person and
$5,500 for a family.
The employee -- or the employer -- can make pre-tax
contributions that can total 65% of the deductible for an individual, 75% for a family. So
if you buy a single policy with a deductible of $1,500, you can contribute $975 (65% of
that amount) to a medical savings account. The money can be used to pay those medical
expenses you incur before you reach the deductible as well as other eligible costs like
eyeglasses and dental care.
If you spend the entire $975, you have to pay after-tax dollars
for medical expenses until you hit the deductible. If you spend less, the money builds up
in your account. You roll it over at the end of the year and you can make another
contribution next year.
You must pay tax and
a 15% penalty on money that is withdrawn from your account for any use other than medical
expenses before age 65. After age 65, withdrawals for non-medical purposes are still
taxable but no penalty applies. An analysis in the June issue of the Journal of Financial
Planning concluded that such accounts could be used to accumulate a nice retirement nest
egg. A person who puts in about $1,500 a year for 25 years could make almost $1 million,
assuming a 10% annual rate of return.
Of course, few people will sail through 25 years without
spending any money on health care.
But these accounts
offer a good deal on the health-care side of the equation, too. I've often wondered why
those of us who are self - employed didn't have the option of using pre-tax money to pay
for contact lenses and root canals like our friends who work for corporations. Now we do. |
|
