How Does a Medical Savings Account Work?

December 10, 2020 · 7 minute read

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How Does a Medical Savings Account Work?

Even for healthy individuals, medical expenses are a fact of life. Whether costs are associated with routine care or an unexpected health problem, health care can be expensive—especially for people who are self-employed and don’t have health insurance through their employers. Opening a medical savings account is one way to help cover these necessary costs.

What Is a Medical Savings Account?

Because they sound similar, many people may be confused between medical savings accounts (MSAs; also called an Archer MSA) and health savings accounts (HSAs).

The two are somewhat similar in that they allow individuals to put money into a tax-free savings account that is dedicated exclusively to paying off certain health care costs.

While HSAs are designed to help employees who are covered by their employers under High Deductible Health Plans pay for certain health care expenses, medical savings accounts are designed to help a more specific group of individuals—those who are either self-employed or work for small businesses.

Medical Savings Plan Contributions

Contributions to a medical savings plan can be made by an individual or their employer to a dedicated account set up through a US financial institution, such as a bank or insurance company. Individuals may claim a tax deduction for any money they contribute to their account through the year, and any contributions made on their behalf by an employer do not count as income. Interest or other earnings on funds within an individual’s medical savings account are not taxed, nor are distributions from that account that are used to pay for qualifying medical expenses.

Also good to note: Money deposited into a medical savings account belongs to that individual. The funds do not expire, even if unused, and such accounts are “portable,” meaning they still belong to the individual even if they switch employers or stop working.

Who Is Eligible for a Medical Savings Account?

To qualify for a medical savings account, individuals must meet one of the following criteria:

•   They must be self-employed (or be married to a self-employed individual), with coverage under a self-only or family high deductible health plan.
•   They must work for a small employer, defined by the IRS as a company with 50 or fewer employees over the last two years, that maintains a high deductible health plan or family plan on the employee’s behalf.
•   They must not have other health coverage beyond the qualifying high deductible health plan, with a few exceptions. These include insurance that covers workplace-related liabilities, fixed coverage for hospitalization, or a specific disease or illness. Additional coverage for accidents, disability, dental, vision, or long-term care would also not exclude an individual from qualifying for a medical savings plan, and those whose spouses are covered under insurance plans that do not meet the high deductible thresholds can still qualify so long as they are not covered under their spouse’s plan.

Individuals who work for companies defined as a “growing employer,” which is a company that started medical savings plans for employees when the business was small enough to qualify and then grew to an average of no more than 200 employees each year, may also qualify for medical savings accounts.

What qualifies as a high deductible health plan? According to the IRS , that’s health care coverage with a higher annual deductible than typical health plans, as well as a maximum limit on annual out-of-pocket expenses.

These limits vary depending on whether the savings account holder has self-only or family coverage. For those with self-only coverage, the annual deductible must fall between $2,350 and $3,500, with out-of-pocket expenses totalling no more than $4,650. For those with family coverage, the limits are slightly higher: deductibles between $4,650 and $7,000 per year are permitted, and annual out-of-pocket expenses cannot exceed $8,550.

There are some additional restrictions on qualifying for a medical savings account people should also be aware of. In order to be eligible, an individual must have either already held a medical spending account in any tax year prior to 2008, or, after that date, they must have entered the program via a qualifying employer.

What Do Medical Savings Accounts Cover?

As anyone with a health care plan is likely aware, individuals are generally responsible for paying for any medical expenses until they reach their annual deductible. Medical savings account holders are able to withdraw money from their accounts in order to cover these non-reimbursable expenses. After an individual pays such an expense, they simply request a reimbursement from their plan administrator.

Such distributions are tax free, so long as they fall under the qualifying medical expenses allowed by the IRS. Withdrawals for other reasons are subject to both income tax and an additional 20% levy.

What does and doesn’t qualify as tax-exempt medical expenses that can be paid for by a medical savings account? A good rule of thumb is that acceptable expenses are similar to those that are considered allowable income tax deductions. IRS Publication 502: Medical and Dental Expenses defines these expenses as “costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and for the purpose of affecting any part or function of the body” including equipment, supplies, and diagnostic devices. Non-prescription medications, other than insulin, also generally do not fit the bill unless they are prescribed by a health care practitioner.

One exception to the tax-deductible guideline is health insurance premiums. Though such fees are legally tax deductible, they generally do not qualify as acceptable medical savings account distributions with a few exceptions. These include long-term care coverage and health care coverage while on unemployment.

Medical savings account holders may also be able to claim distributions for others, such as:

•   A spouse.
•   Dependants claimed on the account holder’s tax return or who could have been claimed on the account holder’s tax return (children of parents who are divorced, separated, or living apart are treated as dependents of both parents).

Must-Know Medical Savings Account Rules

To make the most of a medical savings account—and to avoid tax penalties—it’s important to be familiar with the ins and outs of these types of accounts.

Medical Savings Accounts Have Annual Contribution Limits

While the idea of putting aside money for health care costs and potentially reducing one’s tax bill at the same time may sound appealing, there are limits to how much one can contribute to a medical savings account in a single tax year. Go above these caps, and the excess is no longer tax-deductible and, generally, is also subject to a 6% excise tax.

There are two limits to know about:

•   An individual or their employer may only contribute up to 75% of their annual health plan deductible for families and just 65% of the deductible for self-only plans. If the deductible on a family plan was $5,000, that would cap the annual medical savings account contribution at $3,750. For an individual with a self-only plan with a $3,000 deductible, the annual contribution limit would be $1,950.
•   The contribution can’t exceed the account holder’s net self-employment income (income minus tax-deductible expenses) or income from the employer through which they have the medical savings account.

What happens if someone does accidentally contribute too much? If they catch the excess before their tax return is due, they can simply withdraw the overpayment to avoid the excise tax. Medical savings account holders may also withdraw excess contributions in later tax years, though there are limits to such withdrawals and doing so would not reverse any taxes already paid.

Only an Individual or Their Employer Can Make a Contribution in a Single Year

While either an individual or their employer can contribute to a medical savings account, only one party can do so in a single year—even if the contribution is below the allowable limits.

Medical Savings Account Contributions and Distributions Need to Be Reported in Income Tax Returns

Individuals and their employers have until the tax filing deadline, usually April 15 of each year, to make a contribution, and any amounts contributed up to that date must be reported on an individual’s annual income tax return. Any excess contributions should be included as gross income or reported as “other income.”

Any money withdrawn from a medical savings account must also be reported, and if a distribution is used for a non-qualifying expense, it is subject to tax.

Medical Savings Accounts Must Be Funded in Cash

Unlike some other types of accounts, contributions made to a medical savings account must be made in cash. Deposits of stocks or other investments are not allowed.

The Takeaway

Whether for routine medical expenses or an unexpected emergency, a medical savings account may help some individuals cover the cost of care, while also providing some potential tax advantages. But it’s always good to plan ahead—and health care is just one example of areas where it’s helpful to have some money set aside.

With no account fees and tools that can help you plan for savings, SoFi Checking and Savings® is a partner in saving—both for health care and other important needs.

Learn more about SoFi Checking and Savings®.

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