Health Care Reform: What did the 104th Congress Do? A Discussion About the New Tax-Exempt MSAs!

By Steve Barchet, MD, FACOG, FACPE; Robert Cihak, MD; and Lynn Harsh

What are Medical Savings Accounts?

Under a Medical Savings Account, an employer or employee deposits a predetermined amount of money into an employee’s medical account, out of which each employee pays directly for routine health-related expenses. With most MSAs, two-fifths to three-fifths of the amount previously paid for employees’ health insurance premiums goes into this account (generally around $2,500). The remainder buys a high-deductible major medical insurance policy—sometimes called "catastrophic" health insurance.

The employee uses money directly from the MSA to pay for all smaller and first dollar expenses up to their deductible. All covered health care services above the deductible are paid by the catastrophic insurance. At the end of the year unused funds in an employee’s account belong to the employee.

The Evergreen Freedom Foundation is privileged to count among our technical advisors two physicians whose tireless work, sharp intellect, and investigative expertise in the health care reform arena have proved invaluable. The following narrative is our attempt to describe the recent health care reform bill passed by Congress and the impact this bill will have on individuals and businesses. The "Q" indicates questions asked by Lynn Harsh.

Q. President Clinton recently signed the Kennedy-Kassebaum Health Reform Act of 1996. What does this legislation mean to Americans particularly as it relates to Medical Savings Accounts?

Barchet: The law sets new rules on insurance portability and coverage of pre-existing conditions, and allows a limited number of tax exempt Medical Savings Accounts as a "demonstration project" for people who want to try them out.

Will these tax-exempt Medical Savings Accounts make much difference to Americans?

Cihak: Yes! Although potential economic savings will not be known until these tax-exempt MSA plans have been in place for a while, the new incentive to be a more thoughtful purchaser of medical services is likely to make many people more knowledgeable and confident in their medical decisions.

Barchet: Working with EFF since 1992, we have repeatedly recognized the necessity of once again connecting people using health services to the payment providers receive. Health care reform will have greater success under market-based solutions that give people incentives to directly and actively engage in their own clinical and financial transactions.

Q. Explain this MSA "demonstration project."

Barchet: Effective January 1, 1997, the self-employed, the uninsured, and private employers averaging 50 or fewer employees may establish a Medical Savings Account if coupled with high deductible insurance. These accounts will be tax exempt, but must satisfy specific eligibilities, conditions and limitations established in the law and in treasury regulations.

Q. How are these new MSA plans different from current MSAs?

Cihak: Whereas most current MSAs use after-tax dollars, new qualified MSA plans will be exempt from federal income tax when set up and used for medical expenses.

Q. You use the term "qualified" MSA Plans. What does "qualified" mean?

Cihak: An MSA Plan has two parts, health insurance and a Medical Savings Account.

Barchet: Qualified insurance policies for single persons must have annual deductibles no less than $1500 but no more than $2250. Total out-of-pocket expenses, including the deductible, cannot exceed $3000.

Family policies must have annual deductibles no less than $3000 but no more than $4,500. Total out-of-pocket expenses for families may not exceed $5,500.

Cihak: And also, a tax-exempt savings account to help pay for medical expenses not covered by the deductible must be included.

Barchet: Another qualifying factor: contributions to individually-owned MSAs may be made by an employer or individual, but not both during any year. Contributions to MSAs through flexible benefit plans would not qualify.

Q. So a new kind of health insurance and a new tax-exempt MSA are allowed under the law?

Cihak: No, and yes. The health insurance part of an MSA Plan would be essentially the same as most kinds of health insurance available today, as long as the deductible is in the specified range. But the tax-exempt savings account feature is indeed new.

Q. Will these MSAs make a big difference in people’s medical spending?

Cihak: As always, all economists do not agree. The greatest percentage difference will be noticed among low income workers. For example, one company found average health spending savings of $1,000 per year for each participating employee. $1000 amounts to an extra 5 percent income for someone earning $20,000. For an employee making $100,000 each year, the same $1000 is only 1 percent of additional income.

Q. What is the earliest date someone could be covered by a qualified MSA?

Cihak: For those who are eligible, January 1, 1997.

Q. What do you mean "for those who are eligible?" Who is eligible?

Barchet: Most individuals who are self employed or who have not had health insurance during the previous 6 months are eligible as are employees in firms of 50 or fewer employees.

Businesses with more than 50 employees are generally excluded. So are Medicare beneficiaries, and any person covered by any other health plan (with some exceptions). These are very important exclusions that employers and individuals must take into account.

For example, suppose a spouse or dependent of a public employee already covered by a state plan is offered an MSA by their employer. This family may not establish a tax exempt MSA.

For another example, all military beneficiaries and certain disabled veterans and their dependents are entitled to federal health coverage. They also may not have a tax-favored MSA.

The same prohibition applies to a "covered" spouse or dependent of an employee of a large company, like Boeing, where coverage is provided by the company.

Cihak: The underlying idea seems to be that having both an MSA plan and another health plan would be wasteful "double coverage."

Q. So if I am employed but do not have health insurance through my employer, I would be able to buy my own individual or family MSA plan?

Cihak: Yes.

Q. I understand caps and cut-off dates for MSAs are part of the deal. Why?

Cihak: Because some politicians want it that way. The allowed MSAs will be evaluated for their effects on health spending, health insurance premiums, preventative care, consumer choice and other relevant items.

Barchet: This "demonstration project" lasts 4 years--from 1997 to 2000 unless extended, changed or terminated by Congress. The project permits no more than 375,000 MSA policies in the first year, 500,000 in the second year, 600,000 in the third year and 750,000 in the year 2000. Complicated rules will determine the numbers of allowed MSA Plans that may be established in any of the 4 years.

However, it is possible that high demand will result in one million or more MSAs established in the first 4 months of 1997. As required by law, the Secretary of the Treasury, upon verifying this number, will declare no more tax-favored MSA Plans may be established.

Q. Dr. Barchet, it sounds as if the intent of MSA opponents is in question. Are the caps clearly established in law or is this open to interpretation?

Barchet: I believe too much room has been left for interpretation by those who are not fans of MSAs. A trigger is clearly pulled at some point in time. If an individual or company wants to establish an MSA Plan after April 30th, I advise them to check with a tax attorney or accountant who can follow IRS and Treasury regulations.

Cihak: The law itself says that if "the number of medical savings accounts exceeds 375,000...." [emphasis added] then cut-off dates are activated. This clearly implies Congress allows a higher number. Although I can’t predict what the bureaucrats or the politicians might do in the future, I believe the law allows unlimited MSAs early on.

Q. Since the government is going to limit the time in which MSA Plans can be set up, what is the earliest possible cut-off date for 1997?

Cihak: With a few exceptions, the earliest cut-off date in the law for 1997 would be September 1. In other words, if you are covered by a qualified MSA plan as of that date, you would be able to keep it in the future. If only 375,000 MSAs are established, fewer than 1 percent of American’s would be covered by an MSA Plan.

Q. Is the threshold likely to be exceeded?

Cihak: We think so. Judging from the number of existing non-tax exempt MSA plans and widespread interest, we think that the maximum number of accounts allowed for the whole demonstration project (750,000) will probably be exceeded before April 30, 1997. If one of these numerical limit is exceeded, cut-off dates would be activated.

Q. Could Congress change these dates?

Cihak: Yes.

Q. Suppose I get in under the wire and buy a qualified MSA Plan. Would it be "terminated" when the demonstration project is completed in the year 2000?

Cihak: Not according to current law. But remember, Congress likes to change laws.

Q. Could Congress take away MSAs established within the rules of the new law?

Cihak: Although the United States Constitution (Article 1, Sec. 9) prohibits passing laws that have retroactive effects (this is called "ex post facto"), Congress has passed laws to do so anyway and the Supreme Court has let them stand.

Barchet: All the same, the court of public opinion carries a great deal of weight with Congress. If enough people successfully establish MSAs, Congress will be hard pressed to take a satisfactory product away from happy, voting consumers.

Q. So if I am qualified to try an MSA plan, I’d better not wait for a year to see how things are working out.

Cihak: Right. If you are eligible, it would be wise to have an MSA in place by April 30th. But remember, we cannot predict what Congress or the federal bureaucracy might do in the future.

Q. What if tens of millions of people are covered by MSA plans by September 1997? Will some people have their MSAs taken away?

Cihak: My reading of the law is that they would be able to keep their MSA plans. When the number of accounts reach the thresholds in the law, cut-off dates are activated. But the threshold numbers are not maximum numbers.

Barchet: I believe a question remains on whether or not MSAs established after April 30th, in excess of the cut-off number, will be allowed tax-exempt status.

Q. Do current MSA plans "qualify?"

Cihak: Current MSA plans were not designed to meet the specific limitations in the new law and most probably do not qualify. But many current MSA plans will likely be modified to qualify under the limitations of the new law.

Q. How does a person, or a small employer, get started?

Barchet: First, ask your employer or health insurance agent for an MSA Plan which qualifies under this new law. Interested individuals and employers who want an MSA Plan must ask for them. Establishing the MSA for an eligible subscriber should not be complicated. I recently established my own non-tax favored MSA with American Health Value of Idaho. Within 10 days, they accepted my application, deposited my check in an interest-bearing account with Home Federal Bank of Boise, and sent me an MSA/VISA debit card. I can use the debit card to pay for qualified medical expenses up to the limit of my deposit and from any source in the world that accepts VISA.

Q. Why Boise, Idaho?

Barchet: The answer is simple. I found no bank in Washington interested in an MSA debit card. But I hope Washington banks will respond when enough people ask for the product. So ask your local bank if they will accept MSA deposits and issue an MSA debit card.

Cihak: Institutions that already write MSA plans and have experience in managing them will probably be the first to market qualified plans: insurance companies, health service contractors (such as Blue Cross, Blue Shield, HMOs and PPOs) and insurance agents. Because most people have health insurance through their employer, many employers will likely offer MSA plans.

I think Steve will agree with me that the limits, conditions and other legal booby traps make it most prudent to work with a reputable firm offering MSA plans.

Barchet: Absolutely! I would say "imperative!"

Q. Let’s say I own a small business with 9 employees and provide health insurance for my employees. Would the tax treatment of expenses for an MSA Plan be the same as expenses for my current plan?

Cihak: Yes, as long as the plan qualifies. Money you deposit in qualified MSA Plans for your employees is excludable from gross income and wages for employment tax purposes if only you, as the employer, put the money in. MSA contributions as part of a cafeteria plan are not excluded from income taxation.

Barchet: Employee MSA contributions are deductible meaning mandatory payroll taxes are still paid by employer and employee.

Q. Let’s say I am an employer and already have a non-tax exempt MSA plan for my employees. The insurance part of the MSA plan has a $3000 deductible. I put $2000 into the savings account and the participating employees contribute $1000. Can I set up a similar qualified MSA plan?

Cihak: Not completely. The insurance deductible has to be within the limits listed above. Remember, either you as the employer OR your employee can put money in the account, but not both. In addition, the amount of money going into the account each tax year cannot be more than 65 percent of the health insurance deductible for a single individual, or more than 75 percent for a family.

Q. Would taxes be different if the money was put into the account by the employee rather than the employer?

Cihak: We are not tax experts, but it is our understanding that money paid in by the employer would not be included in wages for calculation of employment tax, thus saving the 15.3% employment tax. If the individual employee puts money in, the employment tax would be paid by both the employer and the employee on the money first.

Q. This sounds complicated. What would that be in real dollars?

Cihak: If $1,000 is put into the savings account by the employer, no employment tax is paid. If the same $1,000 is put in by the employee, $153 must be paid--shared by the employer and employee-- on the $1,000. Ultimately, that $153 in Social Security and Medicare contributions come out of the employee’s compensation, such as $153 less in pay or benefits.

Barchet: Whether MSAs are excludable or deductible makes a very big difference. Whenever earned dollars are excluded from taxable income, those dollars are also excluded from mandatory federal payroll taxes. MSA contributions made by an individual or employee are deductible from taxable income, but are not exempt from federal and state payroll taxes.

Employers, employees and bargaining units may want to review compensation packages in order to determine what forms of employee compensation, including MSA Plans and other benefits, would make the best deal.

Q. Will I owe income tax on MSA earnings if I leave the money in the account?

Cihak: No, the same as earnings building in a qualified retirement plan (such as an IRA or corporate retirement plan) are not taxable, as long as they remain in the account.

Q. Is there a limit on the amount of money that can build up in the MSA?

Cihak: Not in the current law, but of course Congress can change things in future years.

Q. What happens if, after a few years, I end up with a lot of unspent money in my Medical Savings Account?

Barchet: If you are like most MSA subscribers, you will have a significant amount of money left. First, I feel obligated to remind you to preserve your health by ensuring that routine and preventive care is not neglected. With an MSA, you have cash to make this happen.

After you have provided for preventive and routine care, I recommend that you always maintain a full year’s deductible in your medical savings account as a baseline.

Money accumulating in excess of the baseline should be carefully invested to allow maximum income growth. Over time these excess dollars can provide for individual and family long term health care.

Q. What happens when I die?

Cihak: If your medical savings account is willed to your spouse, it can be rolled over into your spouse’s account. If you have not made this provision, it is included in your estate.

Q. What can the MSA money be used for, without paying income tax on the money?

Cihak: Medical expenses which would otherwise qualify as a tax-deductible medical expense. For example, expenses for plastic surgery necessary to restore appearance or function because of an accident or treatment for cancer would qualify. Expenses for plastic surgery for other purposes, such as to remodel your nose, would not qualify.

Barchet: If you spent money from your MSA for something other than a qualified expense, you pay income tax plus an additional 15 percent tax on the amount withdrawn.

Q. Suppose the company I worked for put money into a retirement plan in my name, but I was only 50 percent vested in the plan when I quit. Because of this, I understand the company would keep half the money and I could only roll over half into an IRA. Could this same thing happen with money in an MSA in my name?

Cihak: No, your interest in the MSA is "non-forfeitable," that is, it can’t be taken back, even if every penny was deposited by your employer.

Q. I have to admit, this bill is quite different from what we expected from previous MSA proposals. In fact, it is quite watered down. Is this limited test of only 750,000 MSAs the best Congress could give us?

Barchet: From all I have seen and heard, Representative Bill Archer (R-CA), Chairman of the House Ways and Means Committee, had little choice this year. The political opposition to tax-favored MSAs almost overwhelmed the proponents inside and outside of Congress. Mr. Archer had to be satisfied with this hobbled version or end up with no tax-favored MSAs for anybody. With the November elections closing in, there were no practical political alternatives this year.

This MSA legislation presents a starting point. It is up to all of us to prove this is a better way to buy health insurance.

Q. So, gentlemen, please summarize your thoughts on this issue.

Cihak: MSAs help restore our rights to life, liberty and the pursuit of happiness. They do this by providing positive incentives likely to enhance individual responsibility and a more appropriate relationship between doctor and patient. They help restore the responsibility of limited government to citizens. MSAs also reduce some of the bad economic incentives of the current health insurance system.

Barchet: One of America’s most memorable citizens is famous for advice to people on getting the most value out of purchases made with their earnings. Among other things, Benjamin Franklin advised people to protect the value of their private property from serious financial loss by fire. But he went further. He advised people to purchase higher deductible insurance policies, save the difference in premium paid for first dollar coverage, and in time, the interest would pay for the true insurance. If good economic sense and advice worked for early Americans, surely the same advice will work today.

The Authors

Stephen Barchet, MD, FACOG, FACPE is a technical advisor to the Evergreen Freedom Foundation. Under a grant from EFF, he was the principal investigator of the first comprehensive review of MSA programs in the workplace. Dr. Barchet is the President of the not-for-profit Washington MSA Project which evaluates and publicizes information about MSAs. He conducts MSA seminars around the country and consults with businesses and individuals in matters pertaining to MSA programs. Dr. Barchet lives in Issaquah, Washington.

Robert Cihak, MD, a technical advisor for the Evergreen Freedom Foundation, was the consultant and principal editor for EFF’s groundbreaking publication Medical Savings Accounts: A Building Block for Sound Health Care. He is a graduate of Harvard Medical School and practiced Diagnostic Radiology in Aberdeen, Washington. Dr. Cihak serves as an advisor to numerous institutes and foundations, particularly in policy areas relating to health care reform. Dr. Cihak lives in Aberdeen, Washington.

Lynn Harsh is Executive Director of the Evergreen Freedom Foundation and is the Foundation’s primary writer. She has written and edited numerous articles on health care reform with an emphasis on Medical Savings Accounts. Lynn manages EFF’s Medical Savings Account Project.

Editor’s Note: EFF receives phone calls from time to time asking us to sell a packaged MSA Plan or to provide insurance planning. We do not sell any insurance product, represent any company or engage in financial or insurance planning.

To find out more about the Kennedy-Kassebaum Act HR 3103,, or to read all 349 pages and 175,000 words, you may look on the Internet at http://thomas.loc.gov. Or you may ask your Congressional representative or Senator to send you a copy of the law.

Evergreen Freedom Foundation P.O. Box 552, Olympia, WA 98507 Phone: (360) 956-3482, Fax: (360) 352-1874 Email: effwa@effwa.org