A four-year experiment with tax-free medical savings accounts (MSAs) was launched by Congress, starting in 1997, as a painless way to reduce health care costs. Whether that will prove to be the case will be judged in coming years. But meanwhile, financial marketing marketing are touting them as something else a new way to save for retirement. For healthy families who don't dip much into their MSAs to pay medical bills, this claim may indeed be the case. But owners of MSAs need to be careful how they invest in their accounts, warn financial planners.

The experimental MSAs are limited to the self-employed and employees of small businesses who are covered by a high deductible health insurance policy. The deductible must be at least $1,500 and no more than $2,250 for individuals, or at least $3,000 and no more than $4,500 for families. (The deductible is what the insured pays out of pocket, such as for doctor's visits, before the insurance coverage kicks in.) In addition, the law says that out-of-pocket expenses, which would include such things as co-pays (but not health insurance premiums), cannot exceed $3,OOO a year for individuals and $5,500 for families.

To help pay for these out-of-pocket expenses, the participant makes contributions to the medical savings account. The accounts are opened through insurance companies offering the medical policy, through a bank, or through other qualified institutions. The maximum annual contribution the Person (or the person's employer) can make to the MSA is 65 percent of the deductible for individuals or 75 percent of the deductible for families.

MSAs have been described as individual retirement accounts (IRAs) for medical expenses. All contributions and earnings in the MSA are either tax deferred or tax free, depending on how the money eventually is used. Money withdrawn to pay for ualified medical expenses is not taxed. Money taken out to pay for nonmedical expenses before age 65 (or death or disability) will be taxed at regular income tax rates and is also hit with a 15-percent penalty. Money withdrawn for nonmedical needs at age 65 or later faces only the regular income tax.

Obviously, these accounts could become much more than merely medical IRAs. Healthy individuals or families who make significant contributions and who don't draw heavily on it for medical expenses (or other needs) could accumulate a fairly sizable nest egg by retirement. How much depends on what the MSA offers in the way of investment options. Some MSAs offer only a fixed interest rate- -typically around four to five percent — or money market funds. Others are offering, or will soon offer, more aggressive choices such as stocks, bonds and mutual funds. In effect, MSAs could supplement other retirement account options, such as 401(k) plans and IRAs.

 An MSA outsourcing service, Eclipse MediSave America Corp., calculated that a family making maximum annual contributions to an MSA ($3,375), earning eight percent a year, could accumulate $1,408,813 in the account over 45 years as long as they never touch it to pay for medical expenses. Even if they draw out $1,000 a year, they'll accumulate $991,387.

In another study by the National Bureau of Economic Research, it was estimated that half of all MSA participants would use only 30 percent of their contributions to pay for medical expenses. The remaining 70 percent would grow untouched in the accounts.

However, unlike a retirement account, which is designed to be left untouched for many years, and then drawn down slowly over many more years after retirement begins, the funds in an MSA may need to be tapped virtually without warning. Medical needs rarely are something one can plan for. Indeed, the NBER study noted that one in five MSA participants would save less than half and one in 20 would save less than 20 percent.

To earn eight percent a year, or even higher as some MSA proponents have touted, the MSA's funds will have to be invested in stocks, bonds or similar assets. These investments would typically earn, on average over time, significantly better than more conservative fixed accounts or money markets. But to earn these higher returns entails greater short-term risk. A family would not be happy with the prospect of needing to draw out a major amount from their MSA to pay for medical expenses during a bear market.

Some financial planners are recommending that initial investments in an MSA, and a continuing portion of the MSA, be kept in lower risk assets such as money market funds. A general rule of thumb developing among experts is that you accumulate at least two year's worth of potential out-of-pocket expenses ($6,000 to $11,000) before you begin venturing into riskier investments aimed for retirement.

June -30- 1997