Bob and Penny, owners of a small Central Florida breeding farm, frequently are perplexed, amused, and baffled by Red McNicholls, owner of a larger adjacent property.

This time, as Bob looked over a brochure that McNicholls had given them, he was at once perplexed, amused, and baffled. The brochure outlined how to gain tax benefits from high-deductible medical insurance coupled with an MSA. All characters are fictional, but the situations they encounter are true to life.

"That's too good to be true," Bob exclaimed as he dropped the brochure on the kitchen table. "And since when has Red become an expert in health insurance?"

"Ever since Red discovered high-deductible medical insurance," Penny said, "and since he started an MSA he's become obsessed with the program and touts it to everyone he knows."

"Penny, listen to this," Bob said. "According to Red's insurance brochure, this plan will not only cut our monthly medical insurance premium from $800 to under $200, but it also will allow us to deposit $3,200 per year into an MSA that earns tax-free interest. And on top of all that we can deduct the $3,200 from our taxable income whether or not we itemize our deductions. That is really too good to be true. We'd better call Steve Shades and talk to him about this.

We both know that Red sometimes skates on thin ice with his ideas."

MSAs

Penny reached Shades, an Ocala certified public accountant and their adviser on numerous matters involving the breeding operation that Penny runs and Bob's training business. "Steve," she asked, "are you up to speed on Medical Savings Accounts?"

"Yes, I am," Shades responded. "Let me guess. You've been talking to Red McNicholls, right?"

"Let me have you talk with Bob," Penny said. "I think he's afraid this is some type of a scam."

"Steve, is this real?" Bob asked. "I mean, it looks like they're giving away the farm. Why haven't I heard about this before?"

"It's all true," Shades said. "I recently attended a tax seminar where this subject was covered in depth. I'll fax you some materials from the seminar that will answer most of your questions. In addition to yourselves, you might want to look at this as a way to provide health insurance coverage to your employees."

"Thanks, Steve. I can't wait to see this. We'll be calling you with questions," Bob said and hung up the phone.

With their checkbook stubs, McNicholls's brochure, and Shades's faxed pages in front of them, Penny laid out their current health insurance costs and the costs under a high-deductible plan. Her numbers are in the accompanying table, and the most obvious conclusion is that the high-deductible plan is akin to self-insuring but with a safety net.

Bob was amazed by the ease with which Penny prepared the table, though she confessed she had done some homework after McNicholls first put the brochure in her hands.

"Bob, you must understand some basics about insurance, and especially medical insurance," Penny said. "Most medical claims are relatively minor, say less than $500 in a year for most people. That is why the most popular policies make you pay the first $500 per year of your medical expenses.

Tax-free savings

"Our numbers show clearly that these policies are very expensive," she continued. "But, if we are willing and able to foot the bill for the first $4,800 of annual medical expenses, the insurance company is willing to cut our insurance bill by the amount in the table, from the $800 a month we now pay to less than $200 per month. That is a saving of about $7,000 per year after tax.

In addition, we have the benefit of a savings account that accumulates interest tax-free."

"I still don't get it," said Bob. "Why don't insurance companies sell more of these policies if they are such a good deal?"

"Only the insurance companies know for sure," Penny said, "but the most likely explanation is they can't make money on low-premium policies. Nor can their agents make money on them because of lower commissions, so marketing them is difficult. If you are selling insurance and your commission is 20% of $9,600 or 20% of $2,330, which policy are you going to push?"

"I understand the insurance part of it now, Penny," Bob said. "So where do the MSAs come in?"

"They've been around since 1997, but they haven't been particularly popular because of restrictions put on them," Penny said. "So, for 2001, Congress decided to make them more attractive in the hope of encouraging MSAs and high-deductible, low-premium policies that will enable more people to become insured and at the same time encourage tax-free savings.

"The MSA is like an IRA in that the funds are in a tax-free account. Interest and dividends are not taxed as they accrue. Withdrawals for medical expenses are tax-free. Other withdrawals are taxed like regular withdrawals from an IRA account."

"Okay, Penny, you keep the books," Bob said. "Let's cut to the chase. Does this make sense for us?"

"Bob, I think MSAs and high- deductible policies are perfect for most horse businesses like ours," Penny answered. "They're intended for self-employed people who have fewer than 50 employees and who aren't insured for medical costs in any other way. Here are the advantages:

• "We self-insure up to the amount of the deductible, which means we pay the first $4,800 each year of our medical costs. We've been pretty healthy and have never come close to that much medical cost in any one year;
• "We cut our insurance premium expense. Our monthly payment declines from $800 a month to $200 each month; and
• "If we choose, we can deposit up to 75% of the deductible in the tax-free MSA. The $3,200 in the table is 75% of the $4,800 deductible.

"Although it certainly doesn't apply to our situation, Bob, young people in the horse business also might want to look at the MSA as another way to put away tax-deferred money for retirement," Penny continued. "If you start an MSA when you are young and contribute each year, a large amount of money can be accumulated by retirement age even though the MSA is not a retirement fund as such."

"I see how this would work to our advantage," Bob said, "but what about our employees? Do we have to cover them all, and won't that be too costly?"

"It doesn't have be, Bob," Penny said. "First of all, let's remember that many people in the horse business either do not have health insurance or are underinsured. Certainly, horse people want health insurance for themselves and their families. When horsemen's groups have offered affordable group health insurance, lots of people signed up. At the same time, the coverage became a lot less affordable within a few years because the insurance company saw their costs rise when the insured horse people went for long-deferred treatment of injuries and illnesses.

"As employers, we would offer the high-deductible health insurance as a fringe benefit in lieu of pay. We would buy the insurance and contribute to their MSAs. They aren't taxed on this money, and the payments are a tax-deductible item for our business. If our employees accept this in lieu of pay, we both save money on payroll taxes and at the same time give the workers the health coverage they want while also starting a savings plan for each of them."

"Penny, this sounds real good," Bob said. "But I think we need an insurance professional to help us through the insurance side of it. And we'll need Steve Shades's counsel on setting up the MSAs."

"You're right, Bob," Penny said. "There are some specific rules to follow in writing the insurance plan so all parties can derive the maximum tax advantage.

Plenty of resources for obtaining information on high-deductible medical insurance are available on the Internet. Beyond that, we'll want to check both with our insurance broker-who may have a suitable product for us-and wi