What is a Medical Savings Account (MSA)?
A medical savings account (MSA) is a bank account used for spending on personal healthcare. MSA accounts are an attractive alternative to paying for medical costs out of pocket because they are tax-advantaged.
MSA accounts are similar to health savings accounts (HSAs); the key difference is that MSAs are only available to self-employed people or organizations with fewer than 50 employees.
Both HSAs and MSAs require participation in a high-deductible health plan.
In 2007, the MSA program was discontinued by the US Treasury. People with preexisting MSA accounts can continue to contribute to and use their accounts, but new MSA accounts are not being opened.
How MSA Accounts Work
Medical savings accounts not only let you save money for future medical costs, but they let you do it tax-efficiently.
What makes them tax-efficient is that you are allowed to contribute to them with pre-tax income. However, you can also use MSA accounts to invest in financial assets and avoid incurring taxes on capital gains as long as you use the proceeds for qualified medical expenses.
Contributing pre-tax income to an MSA account means that money comes out of a paycheck and goes directly into the MSA account, avoiding the payment of income taxes.
This has the effect of lowering a person’s total taxable income. For example, if someone has an annual income of $50,000 and they contribute $3,000 to an MSA account, they have reduced their taxable income from $50,000 to $47,000 for the year.
MSA account funds can be invested in financial assets such as stocks and bonds, and without incurring taxes on capital gains.
In a typical brokerage account, if you invest in an exchange-traded fund and sell it at a profit, you owe taxes at the end of the year based on your net realized capital gains.
As long as you use the MSA account for spending on qualified medical expenses, you will not have to pay taxes on investment gains.
MSA Account Limitations
The biggest limitation is that new MSA accounts cannot be created due to current US Treasury policies.
For existing MSA account holders, there are limits to contributions and spending.
There is an annual contribution limit of 75 percent of the account owner’s health plan deductible.
For example, if your annual deductible is $5,000, you can contribute up to $3,750 ($5,000 × 75%) to your MSA that year.
Funds withdrawn from an MSA account must be used for qualified medical expenses; these include doctor visits, dental and vision services, and prescribed medication.
If you use funds for non-qualified purposes, then you must pay taxes on income and capital gains in addition to a 20 percent tax penalty on the funds withdrawn.
The table below provides a summary of the MSA account.