What is a Medical Reimbursement Account?

A medical reimbursement account is a flexible spending arrangement available to American workers that permits them to avoid certain taxes on money they spend to meet medical expenses not otherwise paid for by health insurance. Sometimes confused with a medical savings account, a medical reimbursement account accumulates funds only during the course of a calendar year and must be used for expenses incurred during that year. Medical savings accounts, on the other hand, are usually available only to those with high deductible plans, and are structured to accept contributions and make payments over the long term. Medical reimbursement accounts are one of two types of flexible spending accounts permitted by Section 125 of the US Tax Code; the other is used to pay for dependent care expenses.

A person must be employed to participate in a medical reimbursement account plan, because the only way to put the tax-free dollars into the plan is through a payroll. Participants may elect to have a portion of their compensation deducted from their pay on a pre-tax basis and accumulated in a special, non-interest-bearing account. The election is good only for the current calendar year, and once started, the deductions cannot be changed or stopped except in cases of emergency, or termination of employment. The employer is permitted to cap the annual contribution level, and Internal Revenue Service (IRS) regulations prohibit the contribution of more than $2,500 US Dollars (USD) in any one calendar year. The full amount of the annual contribution is available to a participant immediately after the first deduction is made, a pre-funding feature that sometimes generates controversy.

A medical reimbursement account can be used to pay for qualified medical expenses that aren’t covered by health insurance or otherwise reimbursed. For example, it can be used to pay deductibles for doctor’s office visits and for prescriptions, as well as for medical expenses not covered by a particular health plan, such as dental, acupuncture or chiropractic services. A medical reimbursement account can’t be used to pay for over-the-counter (OTC) medications, though, nor can it be used to pay for cosmetic items, vitamins or nutritional supplements.

Employers sometimes administer their own medical reimbursement account programs, but in most cases, they’re administered for a relatively small fee by service bureaus. Participants may access their funds through a claims process, in which they pay the expense and are then reimbursed by the plan, but many plans now offer a debit card that participants can use at the point of purchase. In either case, they must present proper documentation for all expenses claimed.

Medical reimbursement accounts can only be used to pay for qualified medical expenses incurred in the same year the funds were deducted from the participant’s compensation. The IRS permits a two-and-a-half-month grace period after each year for participants to submit claims, but any funds not used revert to the employer, a feature commonly referred to as “use it or lose it.” Those eligible to participate in a medical reimbursement plan are thus advised to estimate their covered expenses carefully and not contribute more than they anticipate being able to use.

Medical reimbursement accounts are sometimes controversial because of the pre-funding arrangement, which is the feature that permits a participant to access the full amount of the annual election before it’s actually been accumulated in the account. The claim is that employers are unduly at risk because participants who exhaust their medical reimbursement accounts early in the year may subsequently terminate their employment, and are not required to repay the employer the pre-funded amount. The pre-funding feature is the only way to deliver the plan's full benefit to a participant who incurs high medical costs early in the year, however.

To help make up for the potential problems of pre-funding, employers are relieved of payroll tax liability on any amounts deducted for medical reimbursement accounts, which is more than 7.5% of the deductions. In addition, any unused medical reimbursement account funds revert to the employer’s treasury, an amount currently estimated as being about 14% of the total elected deductions. Finally, employers are permitted to impose a cap on contributions below the $2,500 USD cap imposed by the IRS. There does still exist the possibility that a small employer may actually lose money due to pre-funding a medical reimbursement account program, but in the overwhelming majority of cases, the employers stand to gain far more than they might lose due to pre-funding.

Employees who participate in medical reimbursement plans also tend to benefit greatly. Participants in the top income tax bracket who contribute the maximum allowable can save more than $750 in federal income taxes. These benefits makes participating in medical reimbursement accounts a valuable option for employees and employers alike.