Medicare open enrollment is happening right now, and millions of retirees have the opportunity to decide whether to make changes to their coverage. Most people just stick with their current Medicare options year after year without thinking much about the issue, but being on the lookout for smart strategies can produce immense savings.

One little-known option that Medicare participants should look at more closely is the Medical Savings Account, or MSA. By using a Medicare MSA, you can receive substantial contributions toward your healthcare costs that you can use not just now, but in years to come.

The basics of Medicare MSAs

Understanding Medicare's Medical Savings Accounts requires understanding a couple of different aspects of the program. To have an MSA, you need to give up traditional Medicare in favor of a special type of Medicare Advantage plan suited to the account. These MSA-eligible Medicare Advantage plans have high deductibles, and as a result, you'll have to pay a fairly large amount of your initial healthcare costs out of your own pocket each year. If you have an eligible plan, then you'll be allowed to open an MSA, with the plan making some deposits into your account on your behalf in order to cover healthcare costs.

Private insurance companies offer Medicare Advantage plans, and each one has potential MSA customers do things slightly differently. However, what they share in common is that you'll establish an MSA with a financial institution with which your insurer is familiar, and your insurer will take the total amount that it receives from the federal government toward your healthcare costs and apportion it between the costs of your healthcare coverage and your Medical Savings Account.

Medicare enrollment form with red pen lying on top of the sheet.

Image source: Getty Images.

Once there's money in your MSA, you can use it to cover qualifying medical expenses you incur and have to pay as part of your deductible. You can also use MSA funds for copays, coinsurance amounts, or other out-of-pocket needs. There's a recordkeeping component to tracking your eligible healthcare expenses, as you'll need to report them as part of your IRS tax return in order to help the government track the use of the MSA funds.

Why Medicare MSAs are worth a closer look

MSAs are especially appealing to relatively healthy seniors. If you don't end up needing all of the money that your health insurance provider deposits into your MSA, then you're allowed to keep it for use in future years. There's no limit to the amount you can accumulate in your MSA, and any returns that your account generates aren't taxed as long as you use the money eventually for healthcare purposes.

Yet Medicare MSAs aren't necessarily a bad choice even if you're not certain about your health. Deductibles tend to be reasonable, and the deposits that your insurer will make on your behalf will offset some of the deductible amount. You'll almost always have a maximum defined risk from using a Medicare MSA that you can compare against the possible advantages, and make an informed decision based on your own health history and risk tolerance.

However, it's important to understand that Medicare MSAs are intended solely for healthcare. If you take money out of your account and use it for impermissible spending, then the money will be included as taxable income, and you'll also have to pay a 50% tax penalty. That huge hit is intended to make it absolutely clear that seniors shouldn't aim to use MSA funds for other expenses.

How to get more information

The Medicare website has several resources that can tell you about how Medicare MSAs work. A long Medicare MSA pamphlet is available [opens PDF] with detailed examples along with questions and answers, and you can find more basic information at this Medicare MSA webpage.

Medicare MSA plans involve upfront costs of paying a deductible, and that makes many people nervous about considering MSAs. If you're in better health than your peers and have some savings to cover unforeseen emergencies, then MSAs can be a smart way to cut costs and ensure that your healthcare needs will be met in retirement.

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