Medical Spending Accounts: What They Are and How They Work

If you haven't heard of Medical Savings Accounts (MSAs), you're not alone. Although they haven't been well publicized, MSAs offer an excellent combination of cost-control advantages and benefits enhancements that make them attractive to almost any small business.

MSAs can be used by businesses with up to 50 employees and by self-employed individuals. The important thing to keep in mind is that you're using two different plans that work together.

The first component is a high-deductible health-insurance plan (HDHP). This type of plan permits deductibles of at least $1,800 (but not more than $2,750) for singles and at least $3,650 (but not more than $5,450) for families. HMO coverage rarely has deductibles high enough to meet these standards. You can find out more about HDHP insurance plans though your insurance broker.

Aside from the low cost and the high deductible, this part of the plan is no different from any other insurance policy: Employees file their medical-insurance claims the way they would with any other benefits plan, and each year the employer makes a decision about whether to renew the coverage or shop around for a better deal.

The difference lies in the second part of the plan, which is the piece that's known as the Medical Savings Account. Uncle Sam permits participating families to save and invest up to 75 percent of the value of their deductible in an investment account similar to an IRA. For example, if your employees' deductible is $4,500 per family, then each family can invest up to $3,375 in their MSA. (For single employees, the contribution limit is 65 percent of the deductible.) Employees can then use that money to help pay for most of their family's health-care deductible, or, if they are healthy that year, leave the money in the investment account and let it accumulate interest on a tax-free basis until they are ready to retire. Employers can also match employee contributions to the MSA if they so choose.

The downside to setting up MSA plans is that they are more complicated than regular insurance plans. You need to choose not only an insurance carrier but also an investment firm to administer the actual savings accounts. Few banks and investment houses have gotten involved so far, perhaps because demand is still relatively small.

All in all though, MSAs are good news for small business owners. Premiums are very low because of the high deductible, and your employees can save their deductible in a tax-deferred IRA-type account. It's a classic win-win.