Magazine article Risk Management

Cashing in on Medical Spending Accounts

Magazine article Risk Management

Cashing in on Medical Spending Accounts

Article excerpt

Medical spending accounts (MSAs) are a popular fringe benefit offered by many employers. Touted for the potentially dramatic tax savings MSAs can offer employees, large savings are also possible for employers when these accounts are utilized fully.

Employees can set aside part of their salary-before taxes are deducted--for medical expenses. Because putting money into the MSA reduces the employee's taxable salary, the employee does not have to pay federal or state income taxes, or FICA taxes, on that money. Employees can draw money from the MSA to pay medical expenses as these costs arise.

For an employee at a 40 percent marginal tax rate (combined federal and state income taxes and FICA taxes) with $2,000 in medical expenses and $2,000 deposited into a medical spending account, this would amount to $800 in tax savings.

Medical spending accounts also save employers money in two ways. if an employee sets aside more money than is ultimately needed for medical expenses, the extra money is automatically forfeited to his or her employer at the end of the calendar year. The use it or lose it" attribute of MSAs that deter or penalize employee participation provides an obvious windfall for employers. MSA accounts also reduce an employer's portion of the employee's FICA taxes because these taxes are not assessed on the money put into the medical spending account. The more money that employees set aside for MSAs, the better it is for their employers.

ESTABLISHING THE ACCOUNT

When determining the amount of money to place into an MSA, employees must start by anticipating medical expenses they are likely to incur in the coming year. Estimating their expenses will then help employees project their out-of-pocket costs for health insurance deductibles or other expenses that will not be covered by their health plans. Although anticipating medical expenses a year in advance may seem impossible, employees can do a surprisingly good job if they try.

Medical expenses can be broken down into two general types. The first type is medical expenses that are essentially guaranteed. Examples of likely expenses can include routine medical or dental check-ups, regular prescription medications or even elective surgery. If, near the end of the year, an employee still has some funds left in the spending account, he or she may opt to buy a pair of eyeglasses if the purchase could be postponed. It's fairly obvious that these types of medical expenses should be completely covered with medical spending account funds. Employees receive all of the tax benefits, with virtually no risk of forfeiture.

The second type of medical expenses would be emergency or other unanticipated medical expenses. Examples might include an unexpected root canal, a broken arm or an unplanned hospitalization. These accidents may be less common than routine care, but they are usually far more expensive. For employees, debating the likelihood and cost of emergency medical expenses is similar to the frequency/severity tradeoffs familiar to risk managers,

While many employees decide they are "playing it safe" by not putting money into a spending account, this is usually not the best course. When employees realize how much they can save by paying noncovered medical costs with the before-tax dollars in an MSA, these savings generally outweigh the small risk of forfeiture.

Consider the following example. An employee is at the 40 percent marginal tax rate. His child's dentist informs him that there is an 80 percent chance the child will need braces next year, which would cost the employee about $1,200. Let's look at the $2,000 in pre-tax income (subject to $800 in taxes) that would be needed to pay for the braces if the medical spending account were not used. If the employee puts $1,200 of this $2,000 into his spending account, he is guaranteed to have 60 percent of $800, which is $480, left over. If the employee puts nothing into the spending account, there is an 80 percent chance that there would not be anything left of the $2,000 and a 20 percent chance that there will be $1,200 left over. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.