Medical savings accounts and high-deductible health plans open the door to health insurance for those who might otherwise not be able to afford coverage.

The Archer Medical Savings Account (MSA) is named for U.S. Rep. Bill Archer (R-Texas), the lawmaker who wrote the legislation. An MSA is a tax-deferred trust or custodial account, similar to an IRA, in which you set aside money to pay for your out-of-pocket health care expenses and to build up savings for future medical costs.

If you want to open an MSA, it must be pared with a high-deductible health plan (HDHP). Don't be scared off by the name; "high deductible" doesn't mean you must come up with five grand before coverage kicks in.

For 2008, the minimum annual deductible of an HDHP is $1,950 ($3,850 for family coverage). The maximum annual deductible of an HDHP is $2,900 ($5,800 for family coverage). The maximum out-of-pocket expenses limit is $3,850 ($7,050 for family coverage).

By definition, a high-deductible health insurance policy has lower monthly premiums. Thus, the "forced" savings in the MSA combined with low premiums for the HDHP is what, in theory, makes health insurance more affordable: You'll take the money you save on premiums, put it in your MSA and spend it as needed.

In addition, an HDHP may provide preventive care benefits without a deductible or with a deductible below the minimum annual deductible. Preventive care is defined to include services such as periodic health evaluations, well-child care and immunications, routine prenatal care, weight-loss programs, smoking cessation programs and disease-screening services.

Because HDHPs are not "one size fits all," it's important to shop around for a plan that best covers your family's needs. You'll also want to try to predict your health care use for the coming year: The higher your deductible, the lower your premiums will be. If you don't anticipate using the plan much, you might opt for a very high deductible and take a gamble that you won't need to pay the maximum out of pocket.

To qualify for an Archer MSA:

• You must be an employee (or the spouse of an employee) of a small employer (who had an average of 50 or fewer employers during one of the last two years) or a self-employed person (or the spouse of a self-employed person).
• You must be covered under an HDHP and have no other health coverage except permitted coverage.
• You must not be enrolled in Medicare.
• You cannot be claimed as a dependent on someone else's tax return.
• You must be eligible on the first day of the month to take an Archer MSA deduction for that month.

Contributions to an Archer MSA

You or your employer contribute money to an MSA throughout the year or by making a lump-sum payment at the beginning of the year. You cannot both make a contribution in the same year. Your contributions are 100 percent tax deductible. Any insurance company, bank or similar financial institution is allowed to be a qualified MSA trustee or custodian. If you're purchasing a health plan on your own, your health insurance agent can help you set up an MSA or find a qualified company.

There are two limits to the amount that you or your employer can contribute:

• The annual deductible limit: You (or your employer) can contribute up to 75 percent of the annual deductible of your HDHP (65 percent if you have a self-only plan) to your Archer MSA. You must have the HDHP all year to contribute the full amount.
• An income limit: You cannot contribute more than you earned for the year from the employer through whom you have your HDHP. If you are self-employed, you cannot contribute more than your net self-employment income. This is your income from self-employment minus expenses (including the one-half of self-employment tax deduction).

Paying medical costs

Funds in your MSA can be used to pay for "qualified medical expenses," which are expenses that would generally qualify for an IRS medical and dental expense deduction. Examples include doctors' fees, prescription and non-prescription medicines, and necessary hospital services not paid for by insurance. You cannot use MSA funds to pay for your HDHP premiums, but they can be used to pay premiums for long term care insurance, health plan premiums while you receive unemployment benefits, or health continuation coverage premiums (such as COBRA).

You pay your medical expenses by withdrawing money from your account via a "distribution" paid to you by the trustee. A checkbook or a debit card specifically for your MSA may be issued. If you have money left in your MSA at the end of the year, it is carried over to the following year and continues to earn interest.

After you've met your annual deductible, your health insurance policy kicks in. How much of your medical expenses it pays depends on the type of policy you have. In some cases, your health policy will pay 100 percent of your medical expenses after your deductible. In other cases, you'll have to pay 20 percent of the costs, known as coinsurance, which you can also pay from your MSA.

MSA benefits

Some of the other benefits of an MSA:

• You can claim a tax deduction for contributions you make even if you do not itemize your deductions on Form 1040. (If your employer made contributions to your MSA, you are not allowed to take a deduction.)
• You do not have to make a contribution to your Archer MSA every year, nor do you have to make withdrawals.
• The interest or other earnings on the assets in your Archer MSA are tax free.
• Distributions may be tax free if you pay qualified medical expenses.
• The contributions remain in your Archer MSA from year to year until you use them.
• An Archer MSA is "portable" so it stays with you if you change employers or leave the work force.

Small employers also benefit by offering MSAs. Small employers that often change health plans every year not only create administrative headaches for themselves but also disrupt their employees' health care. But with MSAs, employers can buy less expensive health insurance policies and thus are less inclined to change plans every year.

Since taxes can be deferred, some people use an MSA to build up money for retirement. 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 adventurous 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 MSA 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.