Medical Savings Accounts (Posted on May 21, 1997 by )

Carol V. Calhoun, Counsel
Venable LLP
600 Massachusetts Avenue, NW
Washington, DC 20001
Phone: (202) 344-4715
Fax: (202) 344-8300
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Carol V. Calhoun


    On August 21, 1996, President Clinton signed into law the Health Insurance Portability and Accountability Act of 1996 (the "Health Insurance Act"). The purpose of the Health Insurance Act, as stated in the Conference Report, included "to promote the use of medical savings accounts."


    1. Requirements. A medical savings account ("MSA") is a tax-exempt trust or custodial account designed to pay medical expenses. On an experimental and limited basis, self-employed individuals and small employers (employers with up to 50 employees) can establish or allow employees to establish an MSA in conjunction with high deductible health insurance plans. A high deductible health insurance plan is a health plan that has an annual deductible of at least $1,500 and no more than $2,250 for individual coverage or at least $3,000 and no more than $4,500 for family coverage. The plan must also have an annual out-of-pocket expense limit of $3,000 or less for individual coverage and an annual out-of- pocket expense limit of $5,500 for family coverage. These amounts will be indexed for inflation after 1998.

      Subject to certain limited exceptions, an individual covered by a high deductible plan will not be eligible for an MSA if he or she is also covered by a health plan which is not a high deductible plan (e.g., Medicare).

      Any eligible individual may establish an MSA by contacting a qualified MSA trustee or custodian. A qualified MSA trustee or custodian includes a bank, insurance company, an individual previously approved as a IRS trustee or custodian and any other individual who has been approved by the Internal Revenue Service.

    2. Contributions. Cash contributions to MSAs can be made by either the employer or the employee, but not both (employee contributions are not permitted in any year in which employer contributions are made). In addition, an employer making contributions must make comparable contributions for all employees with comparable health coverage.

      The maximum annual amount that may be contributed to an MSA is, for high-deductible individual coverage, 65% of the deductible and, for high-deductible family coverage, 75% of the deductible. Note, however, the annual limitation is calculated using monthly data, based on status, eligibility and coverage on the first day of each month.

      MSA contributions for any year must be made no later than the time prescribed by law for filing the individual’s federal income tax return for the year, without regard to any extensions.

    3. Taxation. Employee contributions to an MSA are deductible (within limits) by the employee, and employer contributions will be excludable (within the same limits) from the employee’s income provided that such contributions are not made through a cafeteria plan. Contributions in excess of the limits are includable in the individual’s gross income and may be subject to a 6% excise tax. Earnings on amounts held in an MSA are not currently taxable.

      Distributions from an MSA for medical expenses are generally excludible from income provided the individual for whom the expenses were incurred was covered under the high deductible plan. Distributions that are not for medical expenses will be includable in income and will be subject to a 15% penalty tax if made prior to age 65, death or disability. Amounts remaining in the individual’s MSA upon death will be includable in his or her gross estate, with special rules if the surviving spouse is named as the beneficiary.

    4. Effective Date. These provisions are effective for taxable years beginning after December 31, 1996. The MSA program is scheduled to end in the year 2000. After the program ends, individuals may continue to receive distributions from previously established MSAs. In addition, individuals who previously made or received MSA contributions may continue to make and receive MSA contributions as long as they continue to satisfy the MSA eligibility requirements. The ability to establish an MSA may end earlier if the number of MSAs established reaches certain statutory limits.