How much can you ante up?

If you decide to open an MSA, understand how much money you can put into it.

You, or your employer, are allowed to make pre-tax contributions to your MSA, but you can't both make contributions in the same year. Further, the amount you can contribute each year is limited by two factors: your annual health insurance policy deductible and your wages or compensation if you are an employee, or your net income from self-employment. An Archer MSA contributions worksheet can help you calculate your maximum allowable contribution.

You can contribute up to 65 percent of your deductible if you have an individual health insurance policy and up to 75 percent if you have a family health insurance policy. Thus, if the deductible for your individual policy is $2,000, you can contribute $1,300 to your MSA each year. And if your family policy deductible is $4,000, you can contribute $3,000 a year.

The amount you can contribute to your MSA can also be limited by your income, though, and if your earnings are very low, you might not be able to contribute the full 65 percent or 75 percent of your deductible since you can't contribute more than your wages. If you are self-employed, you cannot contribute more than your self-employment net income (your gross income minus expenses). You can actually be taxed for contributing too much to your MSA, so be sure you know your limit.

Let's say you earned $25,000 in 2003 and you had a family health plan with a $4,000 deductible. The maximum you can put in your MSA without penalty is $3,000 (75 percent of $4,000).

On the other hand, let's say you opened your own business in 2002, had a rough debut, and netted a modest $1,500. You have a family policy with a $4,000 deductible. Normally, you could contribute $3,000 (75 percent of $4,000). But in this case, you have to take the lesser amount of your income of $1,500 vs. the maximium contribution of $3,000. Thus, you are allowed to contribute only $1,500 for the year.

Archer MSA pros and cons

Proponents of MSAs say the savings accounts encourage people to become more savvy consumers and shop around for health care. Golden Rule Insurance Co., one of the leading providers of MSAs in the nation, says its customers have saved thousands of dollars on such things as baby delivery costs by calling hospitals and comparing rates. Critics contend that MSAs could drive people to hoard their money and not seek out health care when necessary and are not a suitable option for everyone.

There's no doubt that MSAs boast attractive tax and investment incentives. You can invest your MSA money in mutual funds, stocks, or other investments, allowing you to earn higher returns than those afforded by a mere savings account.

Some of the other benefits of an MSA:

• The interest or investment earnings on the assets in your MSA are tax-free.
• You can claim a tax deduction even if you don't itemize your deductions.
• Your contributions to the account remain in your MSA from one year to the next until they are used.
• Employer contributions to your MSA are excluded from your gross income and are not subject to withholding for income tax, Social Security, or Medicare taxes (in some states, they are also exempt from state taxes).
• The MSA is "portable" — you can keep your account even if you switch jobs (as long as the company still qualifies to offer an MSA) or if you leave the workforce.

Since taxes can be deferred, some people use an MSA to build up money for retirement, according to Golden Rule. If you have an annual rate of return of 10 percent (depending on your investments) and contribute $1,500 a year for 25 years, you'll nearly be a millionnaire.

Of course, as with any investment, how you treat your MSA depends on how adventuresome you are and how much risk you can afford. If you have lots of money bankrolled, you can take more risks with it. But if money is tight, you might want to play it safe and keep it in a simple savings account. The IRS has no role in determining your interest rate; it depends strictly on where you invest your money.

Big penalties for nonmedical withdrawals

What if you don't have large medical expenses and would like to spend your piggy-banked MSA money on something else? What if you want to cash out your MSA to pay for your daughter's wedding, for instance?

You might want to think again. You can withdraw money from your MSA to pay for nonmedical expenses — but it'll cost you. You'll have to pay both income tax and a 15 percent penalty on money you withdraw before you reach age 65. After that, you'll still pay tax, but you won't be hit with a penalty. You do not have to pay the penalty if you are disabled or if you die during the year you made the withdrawal — which obviously won't benefit you if you're dead, but could benefit your family.

Another potential drawback to MSAs is the regulations governing them. If you're not comfortable handling IRA-type investments, you might need an accountant to help you sort out all the nuances of MSAs, especially come April 15, when you must determine what distributions are taxable, the proper forms to use, and even where to report all that information on those forms. Back to Page 1.

MSA contributions worksheet   Calculating your annual MSA contribution Sample Your Amount 1. Enter annual deductible amount $4,000 $ 2. Multiply line 1 by 0.75 (or 0.65 if you have a self-only plan) $3,000 $ 3. Divide line 2 by 12 $250 $ 4. Enter number of months you had the health plan during the year 12 — 5. Multiply line 3 by line 4 $3,000 $ 6. Enter wages earned while you had the health plan (or net self-employment income) $25,000 v$ 7. Enter the smaller of line 5 or 6. This is your maximum MSA contribution   $3,000   $ Source: Internal Revenue Service