The relentless rise of health care costs can really put a strain on your household budget. Even with an insurance plan, health care expenses can add up when you consider most people still have to pay deductibles, copayments and other items not covered by insurance.
A great way to offset these rising costs is through the use of flexible spending accounts (or FSAs). FSAs are employer-sponsored accounts that allow employees to make pre-tax contributions. FSAs provide tax savings that help offset health care and dependent day care expenses.
Any contributions you make to your FSA can be used to pay for out-of-pocket medical expenses that are not covered by your health insurance plan – so by taking advantage of FSAs you are, in essence, allowing the government to subsidize a portion of your unreimbursed medical expenses.
How FSAs Work
Let’s say after sitting down and thinking it over, you estimate all of your unreimbursed medical expenses for the coming year will be $1000. At enrollment time, you instruct your employer that you wish to put $1000 in your FSA. Your employer will then deduct a portion of that amount from your paycheck each week (in this case, $19.23) before taxes.
At anytime during the year, you can tap the money in your FSA to cover your qualifying unreimbursed medical expenses, even if your account isn’t yet “fully funded.” In other words, if your FSA contribution for 2010 is $1000, you can withdraw all $1000 to pay for qualifying unreimbursed expenses incurred during the first week of January, even though you’ve only contributed $19.23 into the account.
How do you “tap” the money? I pay the fees in advance and then submit the receipts to my plan administrator who then issues me a check. But I also have the option of using a special FSA debit card as well that will make the payments in real time.
The higher your marginal tax rate, and the more you put in your FSA, the more money you’ll save. Somebody that puts $3000 into an FSA and sits in a 25% tax bracket is essentially saving themselves $750 every year.
That’s $750 of free money – so why would anybody pass that up?
Fear is a Lame Excuse for Leaving Free Money on the Table
As this New York Times article shows, most people fail to take advantage of FSAs because employee contributions to an FSA are “use-it-or-lose-it.” What that means is if you fail to spend the money in the account before the coverage period ends, any unused funds are lost.
What a lame excuse.
Actually, it’s a pitiful excuse – but a lot of people use it anyway. The Times article notes that although 85 percent of companies offer FSAs, only 22 percent of employees take advantage of them.
How sad.
I can understand being afraid of leaving free money on a table if it is being guarded by an angry rattlesnake. But to throw away free money simply because you’re afraid you might not meet some silly little requirement is really inexcusable – especially when you consider all it takes for most folks to avoid that scenario is 30 minutes of their time so they can plan out and estimate in advance their unreimbursed medical expenses for the following year.
With two kids currently wearing dental braces, my unreimbursed orthodontia bills more than cover my $3000 annual FSA maximum limit imposed by my employer. But even when the kids weren’t in the midst of their current orthodontia program, we had little trouble covering the maximum. When you consider eye glasses, contact lenses, saline solution, dentist and doctor copays, unreimbursed prescriptions, cold and other off-the-shelf medicines, band aids, and other qualifying expenses for a family of four, it didn’t take much effort to get there.
Coverage periods depend on your employer’s specific plan, although most plans follow the calendar year. My company’s plan even offers a very generous three-month grace period for filing claims.
If you are still worried about losing money, I would recommend you start slowly and gradually increase your FSA limit each year until you feel more comfortable with the process.
That’s what I did.
The first year I took advantage of an FSA I only signed up for $500. That year I had reached $500 in unreimbursed expenses by June and I remember wishing I had signed-up to put more in my account. The following year I upped my contribution to $1000. By the third year, I doubled it again. I am now contributing $3000 to my FSA and it is a very important benefit I count on every year to help me save money.
Another benefit of the FSA is it acts as a quasi-savings device. We usually compile all of our receipts in a special file and then request our entire reimbursement check all at once sometime in the latter-half of the year. The $3000 check makes for a nice “windfall bonus” that we use to pay for big purchases.
What Are Qualifying Expenses?
Although there are exceptions, the list of qualifying expenses is usually big enough to drive an ambulance through. For a complete list of deductible medical expenses, check out IRS Publication 502. But, as cited in that Times article, here is an example of how varied the expenses are:
– Over-the-counter medicines of all types
– Cough drops
– Calamine lotion
– Mental health therapy
– Lab tests
– Dental braces
– Lasik surgery
– Aids to help you stop smoking
Just keep in mind that, as of 2011, over-the-counter medications must accompany a note from your doctor to qualify as an allowable expense.
Keep in Mind Your Employer Can Make Exceptions!
It is important to know that employers are free to choose what their FSAs will cover. The Times notes that while the vast majority of firms simply follow the IRS rules, some do make exclusions, so check with your employer’s benefits department to see how your company varies from the IRS list of approved expenses.
In Conclusion…
FSAs are something to be embraced, not feared. They not only reduce your tax liability, they also can act as a de facto quasi-savings plan. Yes, if you fail to plan, you may end up losing a portion of your contribution – but that is a poor excuse for passing up one of the more valuable benefits that your employer provides to you.
All it takes is a small amount of planning on your part. 🙂
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I loved my FSA and couldn’t understand why my co-workers didn’t use theirs. For me, as a single parent and living from paycheck to paycheck there was always the worry that I would need cough syrup or ibuprofen for the kids and not have the cash on hand to buy it. It saved my bacon during cold season. And the dependent care FSA was a lifesaver too. I didn’t have to wait for payday to write a check to my daycare, I could write the check when it was due. One year I did over estimate funds and I got designer eye glasses in December and I gave all my friends cough syrup for Channukah. 🙂 As for saving money, yes I saved money on taxes but more importantly for someone living on a very tight budget it was a relief knowing I could buy what I needed for my kids and not have to worry. I’m grateful that I no longer have to live paycheck to paycheck and I will never give up my FSA if my employer offers it. I enjoy your blog, keep it up. Thank you.
I bet you were a hit with your friends that Channukah, Yakira – I mean, who doesn’t love the gift of cough syrup! 😉
But seriously, I think you make some excellent points regarding additional benefits of FSAs – I completely forgot to mention the dependent care FSA.
I much prefer my HSA to any FSA because anything I contribute into my HSA rolls over from year to year.
That is a great advantage of Health Savings Accounts (HSAs) over FSAs! Of course, as you know, not everybody qualifies for HSAs; you have to have a high deductible health plan – otherwise known to most people as catastrophic health insurance.
One way to mitigate the risk of losing FSA funds is to estimate expenses, then allocate a smaller percentage of the estimate to your FSA. So if you spent $1,000 out of pocket last year, you might put 75% of that, $750 in your FSA for the next year.
People who wear glasses or contact lenses are especially suited for FSAs because if you look like you are going to have money left over at the end of the year, it’s really easy to spend down. You can have an eye exam early, buy a new pair of glasses or prescription sunglasses, get new lenses or buy an extra box of contacts.