Medicare Medical Savings Accounts
The Balanced Budget Act of 1997 created a demonstration project for Medicare medical savings account (MSA) plans, but no health plans ever joined the demonstration. The Medicare Modernization Act of 2003 made MSAs a permanent option for health plans in Medicare. As of April 2007, two MSA plans with 2,000 enrollees were participating in Medicare.
A Medicare MSA option has two parts. One part is a Medicare MSA health insurance policy with a high deductible. The other part is a special savings account in which Medicare deposits the difference between the cost of a standard health plan and the cost of the high-deductible plan. Enrollees can withdraw funds from their MSA tax-free to pay for qualifying medical expenses.
Health Savings Accounts
The Medicare Modernization Act of 2003 also created the health savings account (HSA)—a new savings vehicle with special tax advantages that is used only in conjunction with a high-deductible health plan (HDHP). Although created by the Medicare Modernization Act, HSAs are not available to people enrolled in Medicare.
A business may offer a high-deductible health plan and MSA to its workers. An individual who does not have health insurance at work can open a health savings account if he or she purchases a high-deductible health insurance plan.
To be eligible for an MSA, a HDHP must have a deductible of at least $1,100 for an individual and $2,200 for a family in 2008. This means that an individual must pay the first $1,100 each year in medical costs, and a family must pay the first $2,200 in medical bills. Many HDHPs have deductibles that are much higher than these amounts. Also, purchase of certain health care services may not count towards meeting the deductible.
However, the plan is allowed to provide coverage for preventive care, such as an annual physical, mammograms for women, well-baby examinations without a deductible. That might mean a co-payment for the office visit of $20 or $25 when someone gets a physical examination. The purpose of not applying the deductible to preventive services is to encourage their use.
Once an individual has enrolled in an eligible high-deductible health plan, he or she can make a contribution to a health savings account. For 2008, the contribution is limited to $2,900 for an individual and $5,800 for a family. Individuals over the age of 55 can add another $900 to the deposit in the health savings account.
The law says the insurance plan linked to the health savings account must offer financial protection in the event of unusually large medical bills. This requirement aims to prevent an individual or family from being wiped out financially by a catastrophic illness. The out-of-pocket spending limit in 2008 is $5,600 for an individual and $11,200 for a family. Once those figures have been reached, all additional bills are fully covered by the insurance policy.
Both the employer and the worker can contribute to a health savings account. The money can be withdrawn from the account to pay for any qualified medical expenses, meaning any bill submitted by a doctor or hospital. Prescription drugs can be purchased with funds from the account. Payments for over-the-counter drugs also will be reimbursed.
The money is contributed on a pre-tax basis. This can mean significant savings as income rises. The health savings account contribution reduces the tax bill just as an Individual Retirement Account (IRA) deposit would save taxes. For example, a couple in the top tax bracket, 33%, who do not have health coverage through their jobs, might each enroll in an insurance plan with a $2,000 deductible. Each of them deposits $2,000 into a health savings account. They could deduct the $4,000 on their joint federal tax return and save a total of $1,320 on their taxes. The deposit can be repeated each year, offering the same tax savings. The same advantages apply when the money is taken out to pay for medical costs: no taxes are paid.
If the money in a HSA isn't used during the current year, it can be rolled over indefinitely without any penalty from one year to the next. This arrangement differs from the “use it or lose it requirement” applicable to flexible spending accounts (FSAs), which allow workers to use up to $5,000 a year in salary to pay for medical expenses or childcare. In a FSA, any remaining money is lost at the end of the year if it has not been withdrawn to pay bills. Banks, credit unions, insurance companies, or brokerage firms may serve as trustees for health savings accounts, managing the money they contain.
Enrollment in High-Deductible Health Plans and Health Savings Accounts
According to a survey by the Employee Benefit Research Institute and the Commonwealth Fund, 2.3 million people aged 21-64 (1 percent of the privately insured population) are enrolled in high-deductible health plans with a tax-exempt savings account in 2007. Another 12.5 million people have high-deductible plans but no account. (See EBRI Issue Brief No. 315, March 2008.)
Some health experts are concerned that the HSAs could fragment the risk pool for health insurance. It is possible that healthier and wealthier people would opt for the HSAs, because they have the financial resources to handle a large deductible. If this group of people, who are less likely to file medical claims, move in large numbers into HSAs, the pool for comprehensive insurance would have fewer people over which to spread the risk of illness. And many of the people remaining would be those with lower incomes and more serious health problems. Their premiums would rise, reflecting the comparatively high cost of caring for them. However, advocates of HSAs say they would make people more prudent buyers of health care because their own money would be at stake when they decided whether to visit the doctor's office.
Hypothetical Examples of Health Savings Accounts
Jane Smith has a $2,000 deductible insurance plan. She deposits $2,000 into an HSA account. Jane has a healthy year, seeing the doctor twice for office visits when she has a cold and slight fever for which she gets prescription medications. Each office visit costs $35, and the drugs cost another $25 each time, for a total of $120. She pays these expenses from her HSA, leaving a balance of $1880. It carries over into the next year, when she deposits a new $2,000. With the deposit, Jane will have a total of $3,880 for medical bills for the second year. Meanwhile, the account is growing because she has placed the money with a bank, where it is in an interest-bearing savings account.
The money accumulates tax-free, and Jane can withdraw it at any time for medical costs. If the money builds up, it can ultimately serve as a retirement health account. She can use it to pay Medicare premiums, or to pay for long-term care insurance or nursing care, or any other expenses that might arrive along with old age.
Take another individual, John Jones, who also has a $2,000 deductible and opens a $2,000 account. But John isn't as lucky with his health. He undergoes coronary bypass surgery and has a slow recovery, and has a total of $75,000 in medical bills for the year. The coverage provides for 80% payment by his insurance plan and 20% payment by John. He pays the first $2,000, his deductible, and then withdraws the $2,000 from the HSA.
For the remaining $73,000 in medical bills, John's 20% share would be $14,600. However, remember that the out-of-pocket limit for insurance with an HSA is $5,250. John spends $3,250, because he has already paid $2,000, reaching the limit for his personal outlays. All the rest of the money, $69,750, would be paid by the insurance plan.
Next year, John starts fresh with a new $2,000 deposit into his health savings account.
Funds withdrawn for any purposes other than medical care are subject to regular taxation plus a 10 percent penalty.
Money in the account can be used to pay premiums for coverage under COBRA (Consolidated Omnibus Reconciliation Act), which permits an individual to purchase health insurance as part of a former employer's group after a person leaves a job. The former worker must pay 102% of the group rate premium, the full company share plus the worker's share, plus a 2% administrative fee. This can be costly for someone who is unemployed, although it is likely to be less expensive than obtaining an individual insurance policy. Some individuals with health problems might not be able to buy an individual insurance policy because insurers consider them uninsurable, or bad risks. Money from the health savings account could ease this financial burden. COBRA spending for insurance premiums is considered an acceptable use of Health savings account funds.
When an individual reaches age 65, no more contributions are allowed because the individual has now qualified for Medicare. The money in the account can be withdrawn tax free and used to pay for Medicare Part B monthly premiums, or the costs of enrolling in a private health plan that participates in Medicare. The money also could be used for the individual's share of retiree medical insurance from a former employer. These costs can be significant, since many firms are limiting their spending for retiree coverage.