Medical Savings Account Deductions

Medicare and many private insurance policies come with high deductibles. Many people have trouble paying medical expenses while waiting for their deductibles to be met. Medical savings accounts are one way to offset this problem, allowing their owners to take tax deductions for the money that they place in the account.

History

Medical savings account deductions were part of the Balanced Budget Act of 1997. The accounts and the resulting tax deductions were originally offered to Medicare patients. By 1998, 26 states had followed suit and developed legislation allowing individuals to set up medical savings accounts plans and receive income tax deductions. The Health Insurance Portability and Accountability Act (HIPPA) also dealt with medical savings accounts, this time in the personal health insurance market. Under HIPAA, starting January 1, 1997 eligible families and individuals could set up their own medical savings account, and by 1999 around 50,000 people or families were benefiting from these tax deductions.

Function

Medical savings accounts allow their owners to deposit money into the account on a tax-free basis. If the money is deposited after taxes have already been deducted, the account's owner will receive a deduction on his tax return. The interest earned on these accounts is also tax-free. Users can then make purchases of qualifying medical and health-related items without paying income tax on that money. Money can be placed into the account regardless of whether or not it is currently needed to pay for health-related expenses.

Significance

Under HIPAA regulations, only certain individuals or families qualify for medical savings accounts, which are now known as health savings accounts, or HSAs. First, they must be enrolled in a high-deductible health insurance plan as defined by state or federal laws. Second, they have to be self-employed or employed by a business that has 50 or fewer employees. Under the BBA laws, Medicare patients who choose to enroll under the Medicare MSA program can have medical savings accounts.

Benefits

The main benefit of medical savings accounts is the tax savings that their owners receive. When you deduct your medical savings accounts deposits on your tax return, it will lower your total taxible income. The money you paid in taxes on that income will be credited to you. Also, when the withdrawals are used for qualifying medical or health purchases, the money is not taxed. The list of qualifying expenses is quite broad and includes alternative medicine, prescriptions, over-the-counter medications, dental care and chiropractic care. Money can be left in the account to continue to earn interest if it is not used at the end of the tax year.

Warning

Any withdrawals that are made from the account to be used on non-medical expenses are taxable and subject to a 15 percent tax penalty. For this reason, owners of medical savings accounts need to make sure that they want to save the money for medical expenses before placing it into the account. The money in Medicare medical savings accounts is subject to a 50 percent tax penalty if it is withdrawn and used on non-qualified expenses.

Resources

• Medicare fact sheet
• More about medical savings accounts
• Overview of health savings accounts