After a year at my new job the benefit enrollment season just opened again, and I made one change to by benefits that I hadn’t ever done before – I signed up for a Flexible Spending Account (FSA).
For those of you that don’t know, a Flexible Spending Account allows an employee to set aside pre-tax dollars to pay for “qualified” expenses that usually include health care and/or dependent care. I know what you’re asking… Isn’t that why you sign up for health insurance?
A FSA goes above and beyond your typical health care plan by helping you pay for everything your insurance company doesn’t. All those $10 co-pays, deductibles, and prescription drugs can be paid for using pre-tax dollars. Many plans also allow you to pay for vision, dental, and even over-the-counter medication using your FSA!
The plan typically works by allowing you to elect a certain amount to be deducted from your paycheck, before taxes, each month (up to $5,000 per year). As you spend money on plan-covered items, you simply submit a claim for a refund which is paid from your pre-funded plan balance. In recent years, many plans have included a FSA debit card which allows you to directly pay for your medical expenses from your plan balance, without the hassle of submitting refund claims.
But a Flexible Spending Account is not without it’s dangers. One major drawback is that the money must be spent within the coverage period. This coverage period is usually defined as the period that you are covered under the cafeteria plan during the “plan year”. Any money that is left unspent at the end of the coverage period is forfeited back to the company; this is commonly known as the “use it or lose it” rule. However, most plans now allow you to spend any remaining money at the end of the year on non-prescription drugs or medical supplies. So just run to Costco and stock up on Tylenol and Band-Aids!
A second requirement is that all applications for refunds must be made by a date defined by the plan. If funds are forfeited, this does not eliminate the requirement to pay taxes on these funds if such taxes are required. For example, if a single person elects to withhold $5,000 for child care expenses and gets married to a non-working spouse, the $5,000 would become taxable. If this person did not submit claims by the required date, the $5,000 would be forfeited but taxes would still be owed on the amount. (Re-read that last sentence. $5,000 would be forfeited to “the company” and the person forfeiting it still pays taxes on it.)
But the main advantage of a FSA is the tax savings. An FSA allows money to be deducted from an employee’s paycheck pre-tax and then spent on qualified expenses.
For an example of potential tax savings associated with a flexible spending account, a person in the 28% Federal marginal tax bracket and an example 4% state tax (along with FICA taxes of typically 7.65%, for a total tax of almost 40%), could deduct $2,000 and put that money into an FSA for health care. This would result in almost $800 in tax savings. There’s a great little FSA benefits calculator at http://www.ebsbenefits.com/members/fsa_calc.htm#taxsav that will allow help you to estimate your yearly medical expenses, and calculate the potential tax savings from enrolling in an FSA.
So the moral of the story is… if your employer offers a FSA, I would highly recommend enrolling. If your employer doesn’t, then request that they do. Similar to my thoughts on enrolling in your employer’s 401(k) plan, there’s no reason you should be passing up this “free money.” You pay for medical expenses each year, so why not save money while doing it?