Archer Medical Savings Accounts (MSAs) are a variation of Flexible Spending Accounts (FSAs). Both MSAs and FSAs are similar to IRAs in the sense that each employee can make tax-free contributions to an account. But instead of withdrawing the funds at retirement as you would with an IRA, you withdraw them to pay for certain types of medical care. In effect, you're being allowed to pay some of your medical costs with pre-tax dollars, which is a heck of a lot cheaper than paying for it with post-tax dollars.

FSAs have been around for quite some time. Their main drawback is the fact that if an employee places money into an account one year and doesn't use it for reimbursement of medical expenses in that year, he or she loses the money. With an MSA, the money is allowed to accumulate from year to year, to be used in later years when medical expenses are higher or to be saved until retirement.

At present, MSAs that are exempt from federal income taxes are part of a demonstration project that began in 1997 and expired at the end of 2007, although contributions to established accounts can still be made. It was limited to the first 750,000 people who signed up each year and is open only to the self-employed and to businesses with fewer than 50 workers. However, a number of states have MSA laws that permit employers in those states to establish state-tax-exempt MSAs.

Here's how MSAs work. A business may offer its employees, or a self-employed person may purchase, a high-deductible health insurance plan (often referred to as a "catastrophic health plan"). For 2009 and 2010, the deductible must be a minimum of $2,000 for individual coverage and $4,050 for family coverage for 2010 ($4,000 for 2009), and can be as high as $3,000 for an individual and $6,050 for a family for 2009 and 2010. For 2010, the out-of-pocket maximum is $4,050 for individual coverage ($4,000 for 2009) and $7,400 for family coverage ($7,350 for 2009). These amounts may be adjusted periodically for inflation. The employer and employee may then make tax-free contributions to an MSA. Total annual contributions are limited to 65 percent of the deductible for individuals and 75 percent of the deductible for families.

Contributions. In addition to the high-deductible health policy, each employee opens up a MSA savings/investment account. Contributions to the account by an individual are deductible from adjusted gross income, and contributions made by an individual's employer are excluded from income (unless they're made through a cafeteria plan). Contributions may be made for a tax year at any time until the due date of the return for that year (not including extensions). Employer contributions must be reported on the employee's W-2. Earnings of the fund are not included in taxable income for the current year.

Withdrawals. Funds may then be withdrawn from the MSA, tax-free, to pay for minor medical expenses — routine checkups, dental exams, eyeglasses, drugs, even minor surgery. Any funds that are left in the MSA at the end of the year remain in the account, and can be used in succeeding years, or saved until retirement. Thus, unlike flexible spending accounts, there is no "use it or lose it" requirement.

If you have few medical expenses over a period of years, the account may grow to a tidy sum. If funds are withdrawn for nonmedical purposes, a 15 percent penalty will be assessed (plus the funds will be taxed as ordinary income). However, after age 65, you may use your MSA monies for any purpose, just like an IRA, and pay only the tax on withdrawn funds.

Health Savings Accounts. Starting in 2004, Health Savings Accounts (HSAs), approved as part of the Medicare Act of 2003, began replacing MSA programs. HSAs are very similar to MSAs, but they are less restrictive. HSAs are open to all employers, while MSAs are only available to the self-employed or businesses with 50 or fewer employees. In addition, the deductibles for HSAs are lower than the deductibles for MSAs. For HSAs, a high-deductible plan is one in which the minimum deductible is $1,200 for 2010 ($1,150 for 2009) for individuals and $2,400 ($2,300 for 2009) for a family. For 2010, the maximum contribution to an HSA is $3,050 ($3,000 for 2009) for individuals or $6,150 ($5,950 for 2009) for families. Individuals who reach age 55 by the end of the year can increase their annual contributions by $1,000 for 2009 and years thereafter. For 2010, the maximum annual out-of-pocket amount is $5,950 ($5,800 for 2009) for individuals and $11,900 ($11,600 for 2009) for families. These amounts may be periodically adjusted for inflation.

HSAs are not subject to the use-it-or-lose-it regulations of FSAs and unused balances can be rolled over to subsequent years. HSAs are not to be confused with HCSAs (Health Care Spending Accounts) or DCSAs (Dependent Care Spending Accounts) both of which are just another form of FSA.

The IRS has issued model forms for establishing HSAs. Form 5305-B, Health Savings Trust Account, and Form 5305-C, Health Savings Custodial Account, are used to establish HSAs and are not to be filed with the IRS. The forms and their instructions are available on the IRS web site.