I am a big fan of flexible spending accounts and have used the medical one for as long as I can remember. In this article, I'm going to walk you through the reasons I use an FSA. I'll also help you overcome the fear of the use it or lose it provision that keeps most employees from using their FSA at work. Are flexible spending accounts a good idea? Read on to find out.
What is a Flexible Spending Account?
A flexible spending account is actually primarily one of two different types of accounts. First, there's a medical flexible spending account that can be used for eligible medical expenses. The second type of flex account is a dependent care account that can be used for eligible dependent care expenses.
Both types of flexible spending accounts are funded by contributions made entirely by the employee and are not funded by your employer. However, your contributions are made on a pre-tax basis which reduces your taxable income.
Medical and dependent care accounts are separate accounts. This means you'll have to decide how much money you want to go into each account if any. You can do just a medical flex, just a dependent flex or both.
Besides being different accounts, the medical and dental FSA's operate a little differently. While a medical FSA comes attached to a debit card and the money can be spent before it's fully funded, the eligible dependent care claims must be filed and the money must already be deposited before claims can be paid.
I have never used the dependent care FSA for my own expenses so most of my discussion here will center around the medical FSA which I have used for years.
Who Should Use A Flexible Spending Account?
If you know you are going to have eligible expenses and are going to spend the money anyway, then a flexible spending account is a great tool to reduce your taxes.
A good example of a good FSA candidate is if you are someone who has a chronic condition, has prescriptions every month, a sizable deductible that you know you are going to meet, then you'll want to check into using an FSA. (* Please note the FSA vs HSA discussion below.)
If you know you are not going to spend any money that would qualify as an eligible expense during the year unless it's totally unexpected, then an FSA isn't for you. The FSA is strictly for people who know they will have eligible medical expenses.
In my case, I already know when the plan year starts that I'll have more expenses than the limit on the amount I can put in there. That's why I max it out. Obviously, if you don't have any planned eligible expenses, you wouldn't want to put money into it.
Otherwise you'll just lose it.
Three Reasons to Use a Flexible Spending Account
There are three reasons to use a flexible spending account.
- Reduce your taxable income (and possibly increase your net take home pay) Every contribution to your FSA goes in on a pre-tax basis. This means your overall tax liability decreases and your net paycheck might actually go up slightly. You'll want to check the limits each year but as of 2017, the max amount you could contribute was $2,600 per plan year. If you want to get a good idea of how much money you'll save in taxes and how much your net paycheck will go up, here's a good FSA calculator here. I plugged in an example of a person making $40,000 per year and putting in the max of $2,600. The estimated tax savings was $623 for the year but more importantly, the estimated net paycheck increased by 3 percent.
- Advance your contributions on day one (for medical FSA's only) While the tax advantages are great, probably the best thing a medical FSA has going for it is that your funds are available on the first day of your plan year even if you haven't had them deducted from your paycheck yet. So, if you have expensive prescriptions or eligible medical expenses you need to pay for before your deductible is met, this is a great way to take a big bite out of that. Keep in mind, your deductible on your health plan may be higher than what you can put into it.
- No repayment required if you terminate employment If you leave employment prior to the end of the plan year and have used all your medical FSA money, your employer cannot collect the balance. That's because the use it or lose it provision goes both ways. This is why there's often a waiting period to become eligible for a medical FSA. They want to make sure you are going to stick around so they don't get stuck making up the difference.
Those are three of the main reasons I've found that make using an FSA, or at least the medical FSA, worthwhile.
Flexible Spending Account vs HSA (Health Savings Account)
Health Savings Accounts or HSA's are another way to pay for eligible medical expenses. However, you can't do both an FSA and an HSA at the same time. The rules on pretax contributions on different plans can get tricky. The government only wants to give you so much pre-tax eligibility. So if you have any questions about these two types of plans, you'll want to check the rules in place at the time.
While you can put more money in an HSA on a pretax basis than an FSA, the money has to be in an HSA before you can use it. This is unlike the FSA which will advance the money on day 1.
If you are user of your medical plan, it's possible the higher pre-tax limits might be beneficial to you. However, the goal of an HSA is to accumulate the difference in the money you save in premiums by opting for a high deductible plan as opposed to a lower deductible plan to use later.
I've always felt if you are going to use all your contributions that would have gone into an HSA during the plan year and have a zero balance at the end of it, it's probably not worth the hassle of the HSA personally. But you'll have to look at that for yourself to see what you want to do.
In actuality most people just opt for a high deductible plan either because they have no choice in plans or they just want a lower premium. Very few people actually take the savings from the premium between a high deductible plan and a low deductible plan and set it aside in an HSA. This is because a lot of people just don't feel they can afford to do that.
What you want to remember is that if you are spending after tax money year after year on eligible expenses, you can save on your taxes and increase your net take home pay slightly in most cases by using one of the two.
How To Deal With The Use It or Lose It Provision
The biggest turnoff to the flexible spending accounts is the use it or lose it provision. While some FSA plans have a a carry over provision, many instead have a deadline to file claims. If you don't have eligible expenses, you can't get your money out of the FSA.
I've witnessed people just have to let the money go unclaimed either because they were too lazy to file the claims, didn't have eligible expenses or didn't comply with providing needed documentation to the third party administrator who handles the FSA administration.
When I talk with employees who I know will have eligible medical expenses but are afraid to use the account because of the use it or lose it feature I always tell them that the easiest way to get used to how the FSA's work is to start small. If you know you'll meet your deductible every year but are wary of the FSA, start with a $200 or so. Choose an amount you know you will use.
Then, once you are comfortable with how the mechanics of getting your money out of the FSA works and notice you are running out of money in the first quarter, then look at increasing it the next year.
This is what I did many years ago and now I already know I'll use all max when the plan year begins. In fact, I wrote this in July and already used all my FSA money a month and half ago.
Caution! Proper Documentation Needed
With some employees I've talked to, they've told me that the third party administrator makes them provide so much documentation that it's such a hassle to get their money out. Remember, first make sure you are using your funds for eligible expenses. Here's a good place to start to see what type of expenses are eligible.
Next, make sure you keep receipts for all eligible expenses You'll need to submit those to document your expenses. I know the FSA I use has an app on my iPhone and I have to upload pictures of receipts for my transactions. If I don't they reject my expense.
Finally, make sure the expenses are for the plan year the funds are deposited. You can't use funds for the current year for prior year or future year expenses.
If you find that the administrator of the FSA your employer is using is requiring you to just through more hoops than you think should be necessary then be sure and report that problem to your employer. They need that information and can also help you resolve it.
Conclusion
If you are spending money on eligible medical and dependent care expenses already, a flexible spending account is a great way to reduce your tax liability and possibly increase your net take home pay just by changing how you spend the money.
Will you have eligible expenses and are afraid of the use it or lose it provision? Then start small until you get a real good feel for how the flexible spending account works.
Once you understand it, and learn that it's easier than expected, you'll eventually learn how much you should put into one each year.
Let me know in the comments if you use an FSA (or HSA). I'd love to hear what you think!
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