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Consider Health and Medical Savings Accounts as an Employee Benefit

Filed under Managing the Workplace. Fact checked on January 14, 2014.

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Health Savings Accounts (HSAs) allow employees to make pre-tax contributions to an account that can be used for health care expenses. HSAs are a newer form of health insurance benefits and have been increasing in popularity in recent years.

Employers who are looking for a different method of delivery for health care benefits are increasingly turning to health savings accounts (HSAs) as an option. HSAs and their older version, medical savings accounts (MSAs) are a variation of flexible spending arrangements (FSAs).

How do these type of accounts work? Employee can make tax-free contributions to an account and withdraw them to pay for certain types of medical care. Pre-tax dollars are being used to pay for medical care. With an MSA and an HSA, the money is allowed to accumulate from year to year, to be used in later years when medical expenses are higher or to be saved until retirement.

Medical Savings Accounts (MSAs)

At present, MSAs that are exempt from federal income taxes are part of a demonstration project that began in 1997 and expired at the end of 2007, although contributions to established accounts can still be made. It was limited to the first 750,000 people who signed up each year and is open only to the self-employed and to businesses with fewer than 50 workers. However, a number of states have MSA laws that permit employers in those states to establish state-tax-exempt MSAs. Health Savings Accounts (HSAs) began replacing MSAs in 2004.

For MSAs, a business may offer its employees, or a self-employed person may purchase, a high-deductible health insurance plan (often referred to as a "catastrophic health plan"). For 2014, the deductible must be a minimum of $2,200 for individual coverage ($2,150 for 2013) and $4,350 for family coverage ($4,300 for 2013) and can be as high as $3,250 for an individual ($3,200 for 2013) and $6,550 for a family ($6,450 for 2013).

For 2014, the out-of-pocket maximum is $4,350 for individual coverage ($4,300 for 2013) and $8,000 for family coverage ($7,850 for 2013).

These amounts may be adjusted periodically for inflation.

The employer and employee may then make tax-free contributions to an MSA. Total annual contributions are limited to 65 percent of the deductible for individuals and 75 percent of the deductible for families.

MSA contributions. In addition to the high-deductible health policy, each employee opens up a MSA savings/investment account. Contributions to the account by an individual are deductible from adjusted gross income, and contributions made by an individual's employer are excluded from income (unless they're made through a cafeteria plan). Contributions may be made for a tax year at any time until the due date of the return for that year (not including extensions). Employer contributions must be reported on the employee's W-2. Earnings of the fund are not included in taxable income for the current year.

MSA withdrawals. Funds may then be withdrawn from the MSA, tax-free, to pay for minor medical expenses such as dental exams, eyeglasses, drugs, and minor surgery. Any funds that are left in the MSA at the end of the year remain in the account, and can be used in succeeding years, or saved until retirement.

If you have few medical expenses over a period of years, the account may grow to a tidy sum. If funds are withdrawn for nonmedical purposes, a 15 percent penalty will be assessed (plus the funds will be taxed as ordinary income). However, after age 65, you may use your MSA monies for any purpose, just like an Individual Retirement Account, and pay only the tax on withdrawn funds.

Health Savings Accounts (HSAs)

Health Savings Accounts (HSAs), approved as part of the Medicare Act of 2003, are the replacement for MSA programs. HSAs are very similar to MSAs, but they are less restrictive. HSAs are open to all employers, while MSAs are only available to the self-employed or businesses with 50 or fewer employees.

In addition, the deductibles for HSAs are lower than the deductibles for MSAs. For HSAs, a high-deductible plan is one in which the minimum deductible is $1,250 for individuals and $2,500 for a family for 2013 and 2014.

For 2014, the maximum contribution to an HSA is $3,300 for individuals ($3,250 for 2013) or $6,550 for families ($6,450 for 2013). Individuals who reach age 55 by the end of the year can increase their annual contributions by $1,000.

For 2014, the maximum annual out-of-pocket amount is $6,350 for individuals ($6,250 for 2013) and $12,700 for families ($12,500 for 2013).

These amounts may be adjusted for inflation.

HSAs are not to be confused with Health Care Spending Accounts (HCSAs) or Dependent Care Spending Accounts (DCSAs), both of which are just another form of FSAs.

Model forms for establishing an HSA. The IRS has issued model forms for establishing HSAs. Form 5305-B, Health Savings Trust Account, and Form 5305-C, Health Savings Custodial Account, are used to establish HSAs and are not to be filed with the IRS. The forms and their instructions are available on the IRS web site.

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