Medical Savings Accounts
Medical Savings Accounts (MSAs) are part of an approach to paying for medical care designed to put consumers in control of a portion of the money that's spent on their behalf. The MSA itself is a tax-exempt account, similar to an Individual Retirement Account (IRA), used to pay for eligible medical expenses. The MSA is intended to pay for most routine medical expenses. It can only be established in conjunction with a qualified high-deductible health plan, which provides protection against the potentially catastrophic expenses of serious illness or injury.
Money that an individual contributes to the MSA is deductible (within limits) for federal income tax purposes. Employer contributions are excluded (within the same limits) from the individual's gross income for federal income tax purposes (and are also exempt from federal employment taxes). Any interest earned on funds in the account is also excluded from gross income.
In general, funds withdrawn from an MSA are also excluded from income if they are used to pay for qualified medical expenses for the account owner or a member of the owner's family. "Qualified medical expenses" are the medical expenses that can be deducted for income tax purposes (when they exceed 7.5 percent of adjusted gross income). Funds may also be withdrawn free of federal income tax to pay premiums for long-term care insurance, "COBRA" continuation coverage, or to pay for health insurance while unemployed and receiving unemployment compensation.
Withdrawals made for other purposes are subject to federal income tax. They are also subject to an additional 15 percent excise tax (unless the account holder is age 65 or older, disabled, or has died).
Flexible Spending Accounts
A Flexible Spending Account (FSA) is a type of benefit plan in which individuals put aside a certain percentage of their salary each year to reimburse themselves for out-of-pocket expenses not covered by other plans.
The dollars that go into an FSA are pretax dollars, meaning the contributions to the FSA are deducted from a given paycheck before federal and Social Security taxes are withheld. (FSA contributions are sometimes exempted from state and local taxes, too.) This results in lower taxes overall and an increase in disposable income. Bear in mind, however, that money contributed to an FSA must be spent in the course of a given calendar year. At year's end, unspent funds are forfeited.
So it's best for people to plan carefully and not overestimate the amount of money they'll need for otherwise uncovered medical expenses.
