Close-up: Health Spending Accounts

Physician's Money Digest, July 2006, Volume 13, Issue 7

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Health Spending Accounts: Accounts that individuals can use topay for health care expenses not otherwise covered by a health plan.

Life doesn't always offer us choices when makingimportant financial decisions. But when it comes tohealth spending accounts, there are actually threedifferent types that can be used by physician practices tohelp their employees fund health care expenses. The listincludes flexible spending accounts, medical savingsaccounts, and health reimbursement arrangements. Thereare some elements common to all three account types, butthere are some major differences as well to be considered.Which one is right for you?

Flexible Spending Accounts

The US Department of Labor defines health care flexiblespending accounts as "employer-established benefitplans that reimburse employees for specified medicalexpenses as they are incurred." These plans are alsoknown as cafeteria plans or 125 plans, the latter namederived from section 125 of the Internal Revenue Codeunder which it falls. Employees contribute to theseaccounts through salary reduction agreements that enablethe funds that are set aside to be free of income and SocialSecurity taxes. In some cases, employers contribute to theaccounts as well.

USA Today

An article in points out that while approximately22 million people have access to these types ofaccounts, only 7 million are taking advantage of them. Thekey reason is the "use it or lose it" provision attached to theaccounts. Any funds placed in the account that are not spenton qualified medical expenses during the calendar year arenot returned to the employee. And while Congress has consideredbills that would allow up to $500 to be carried overto the following year, no legislation has been enacted.

Medical Savings Accounts

This second health spending account option becameavailable on January 1, 1997, having been authorized by TitleIII of the Health Insurance Portability and Accountability Act(HIPAA) of 1996. Here the employer or the employee makescontributions to the account—not both parties.

This type of account can be utilized by physicians whoare self-employed or are employed by a practice with fewerthan 50 employees. In either case, the holder of theaccount must be covered by a high-deductible health insuranceplan. However, with a medical savings account, fundscontributed may be rolled over every year, and are portableif the physician should move to a different practice.

The Department of Labor notes that the funds contributedto the account also accumulate earnings, which"are not taxed unless funds are withdrawn for nonmedicalexpenses." In the latter scenario, the savings not onlybecome taxable, they are also subject to a 15% penalty tax.Also, it is important to note that people over age 65 are ableto withdraw funds for nonmedical purposes without incurringa penalty; they are, however, obligated to pay incometax on the amount withdrawn.

Health Reimbursements

This last option, also known as health reimbursementaccounts or personal care accounts, is probably the leastwell known of the three. It's also the most recent account,becoming effective just 4 years ago.

With a health reimbursement account, employers setaside funds used to reimburse employees for qualifiedmedical expenses. Employers, according to the Departmentof Labor, "qualify for preferential tax treatmentof funds placed in a health reimbursement account in thesame way that they qualify for tax advantages by fundingan insurance plan." Employers provide all of the fundingfor this type of account.

The big difference here is that health reimbursementaccounts are not limited to current employees of smallbusinesses. Any unused funds are rolled over at the end ofthe calendar year, and former employees, such as retirees,have continued access to unused dollars remaining in thefund. Keep in mind, these accounts are not portable,should an employee leave a company.

Fast Facts about MedicalSavings Accounts

Kiplinger's Personal Finance

Medical savings accounts (MSAs), first introducedon January 1, 1997, are becoming one ofthe more popular forms of health spendingaccounts. Here, excerpted from a recent article in, are some ins andouts regarding these accounts.

•Any individual under age 65 with a qualifiedhigh-deductible policy can open an MSA, but theymay not be simultaneously covered by anotherhealth insurance policy that is not a qualifiedhigh-deductible plan.

•In 2006, single people are able to contributeup to $2700 annually to an MSA and up to $5450for families.

•There are no income limits on individualswho wish to purchase an MSA.

•If you withdraw funds from your MSA fornonmedical expenses after age 65, there is nopenalty, but you would have to pay income taxeson the amount withdrawn.

•If you're on your own, you can find a list ofhealth insurance companies that offer MSA-eligibleplans in your state online at HSAInsider.com orat HSADecisions.org.

POPQUIZ

1) How many different types of health spending accountsare there?

  1. 2
  2. 3
  3. 4
  4. 5

2) Which type of account does not allow contributionsto be carried over?

  1. flexible spending account
  2. medical savings account
  3. health reimbursement account
  4. all of the above

3) Medical savings account contributions may be madeby the following person:

  1. the employer
  2. the employee
  3. both
  4. either/or

4) If medical savings account funds are withdrawn fornonmedical reasons by a person younger than age 65,they are subject to a penalty tax of

  1. 5%
  2. 10%
  3. 15%
  4. 20%

5) The cutoff age for someone opening a medical savingsaccount is

  1. 55
  2. 60
  3. 65
  4. 70

Answers: 1) b; 2) a; 3) d; 4) c; 5) c.