Medical Savings Account (MSA): Meaning, History, Types

What Is a Medical Savings Account (MSA)?

The term medical savings account can refer to any of several tax-benefitted arrangements enacted since the early 1990s. However, it also refers to a specific type of medical savings account (MSA) that was authorized and regulated under the Internal Revenue Code in the early 1990s. This type of account evolved into a health savings account (HSA).

Some Medicare Advantage plans offer Medicare MSAs. These accounts are regulated by the administrators of Medicare, the Centers for Medicare and Medicaid Services.

Understanding Medical Savings Accounts (MSAs)

Medical savings accounts (MSAs) were first created by several states in the early 1990s. By 1996, these plans became a federal pilot program within the Health Insurance Portability and Accountability Act (HIPAA). Medical savings accounts enjoyed tax benefits under the Internal Revenue Code and were models for succeeding medical savings arrangements.

The original type of MSA, which could be used by individuals who were either self-employed or members of small group plans and enrolled in high-deductible health plans (HDHPs), was phased out in 2003. However, MSAs structured as Archer MSAs were permitted to continue, although no new Archer MSAs may be created.

In 2003, a new tax-benefitted arrangement, a health savings account (HSA), was enacted as part of the Medicare Prescription Drug, Improvement, and Modernization Act. Rules similar to those for MSAs (related to eligibility, HDHP deductibles, contributions, and tax treatment) apply to HSAs. A broader range of individuals can benefit from HSAs than were eligible for the original MSAs; HSAs are available to employed, self-employed, and unemployed individuals. An employee or an employer (or both) can contribute to an HSA. 

Some employees may be offered other employer-sponsored programs that provide tax-favored healthcare savings. Health reimbursement arrangements (HRAs( are funded solely by the employer. On the other hand, the employee or employer (or both) may contribute to flexible spending arrangements (FSAs).

History of Medical Savings Accounts (MSAs)

Medical savings accounts were put in place to make the high cost of healthcare services more affordable for Americans. Funding for the first MSAs was contributed by the individual or the employer, but not by both. MSAs were limited to the self-employed or employer groups with 50 or fewer employees, and they were subject to requirements relating to eligibility, contributions, and use of funds. Participants had to be enrolled in a high-deductible health insurance plan (HDHP). Individuals did not pay tax on their own (or their employer's) contributions. MSA distributions were tax-free if used for qualified medical expenses.

These arrangements were succeeded by HSAs, which continue to be available. HSAs adopted a structure and rules similar to those of MSAs, including the requirement that each account is coupled with an HDHP.

Types of Medical Savings Accounts (MSAs)

Medicare Medical Savings Accounts (MSAs)

Medicare MSAs are available with high-deductible Medicare Advantage (MA) plans (Medicare Part C). The MA plan deposits funds to the insured's MSA, allowing the insured to use the funds to pay for medical care even before the deductible is reached. The Medicare MSA is similar to an HSA, allowing users to choose their healthcare providers and services. However, although Medicare MSA funds may be used for services not covered by Medicare, only the cost of Medicare services will be counted toward meeting the deductible.

For an extra cost, some Medicare MSAs cover extra benefits not covered by the MA Plan—for example, dental care, vision care, hearing aids, and long-term care. However, Medicare MSAs do not cover prescription drugs. Enrollment in Medicare Part D is required for Medicare coverage of prescription drugs.

Archer Medical Savings Accounts (MSAs)

Before 2008, self-employed individuals and small businesses with fewer than 50 employees who HDHPs covered were able to create MSAs, known as Archer MSAs, which were set up as tax-exempt trusts or custodial accounts with U.S. financial institutions. Archer MSAs generally worked in the same way as the original MSAs did. (The original MSAs were discontinued in 2003.) The law authorizing Archer MSAs expired as of Dec. 31, 2007. Because they were discontinued, no new Archer MSAs were created after that year. However, existing accounts were permitted to continue to receive and distribute funds.

Individuals’ contributions into Archer MSAs were tax-deductible. Currently, contributions into Archer MSA accounts that have been legacied are tax-deductible (whether or not the contributor itemized deductions). Employer contributions are not taxable to the employee. Only contributions in cash are permitted. Interest or other earnings and distributions to cover the cost of qualified medical expenses are tax-free. At year-end, unused balances can be rolled over to the following year. If insured individuals change jobs, the Archer MSA can move with them to the next employer, and they can make additional deposits provided they continue to be eligible.

Special Considerations

In 2003, the Medicare Prescription Drug Improvement and Modernization Act authorized the creation of health savings accounts (HSAs) to help pay the medical expenses of individuals enrolled in high-deductible health plans (HDHPs). These accounts became a permanent feature of the tax code. 

Contributions to HSAs reduce federal taxable income. HSAs are available to any eligible individual with an HDHP, whether self-employed, unemployed, or employed by a small or large company. If an employer contributes to an HSA—or an employee contributes through payroll deductions—the amounts are excluded from the employee’s taxable income. Direct contributions by self-employed and unemployed individuals are tax-deductible, whether the individual claims the standard deduction or itemizes. Funding can be made anytime between the beginning of the calendar year and before the tax filing deadline for that year. Distributions to pay for qualified medical expenses are tax-free.

Sources: Internal Revenue Service.

An HSA is a fully vested account; funds are not subject to forfeiture if they remain unspent at the end of the year. The IRS announces annually the HSA contribution limits and the required, inflation-adjusted HDHP amounts for the minimum health plan deductible and the ceiling on out-of-pocket expenses for both self-only and family coverage. Individuals age 55 and older are entitled to an additional contribution amount annually. Individuals enrolled in Medicare cannot contribute to HSAs, but they can make tax-free distributions from any remaining balance in an HSA to pay for qualified medical expenses.