You can’t predict every health or dependent care expense, but you probably can estimate most of them, at least the ones you can expect. The ability to estimate these expenses is key if your employer offers flexible spending accounts, which can help you save money and reduce your federal income tax. Keep reading to learn about the types and pros and cons you should consider before you invest in a flexible spending account.
What Is a Flexible Spending Account?
An FSA is a special account that lets you set money aside, tax-free, for out-of-pocket medical, dental and vision expenses or dependent care costs. Employers offer different types of FSAs, and the type you choose depends on your healthcare and dependent needs.
Types of Flexible Spending Accounts
All FSAs are pre-tax benefit accounts that are offered by employers. Here are the three types of FSAs:
- Healthcare FSA: An HCFSA allows you to save around 30 percent on allowed healthcare expenses. Allowed health FSA expenses include medical, dental and vision expenses not covered by your insurance.
- Limited Expense Healthcare FSA: Use a LEX HCFSA for qualified out-of-pocket dental and vision care expenses. It’s available to employees enrolled in a Federal Employees Health Benefits high-deductible health plan who have a health savings account or who have a spouse enrolled in a high-deductible health plan and an HSA.
- Dependent Care FSA: Employees can use a DCFSA to pay for allowable dependent care services like daycare, preschool or after-school programs — but not dependents’ healthcare expenses. The IRS Dependent Tax Care Credit might be more beneficial than a DCFSA. Consult with your tax advisor to understand your options.
Pros of Flexible Spending Accounts
An FSA might be a good fit if you anticipate high medical expenses in the next year, or you care for a dependent. Here are some perks:
- Tax Savings: Employees contribute to their FSAs through payroll deductions, so the money is taken out before taxes. This reduces your taxable income, which means you’ll owe less to the IRS.
- Medical Savings: Health insurance doesn’t always cover auxiliary healthcare costs such as over-the-counter prescriptions, travel vaccines and diagnostic tests. You can pay for these items with your FSA.
- Family Healthcare Coverage: You’re not the only person who can take advantage of your HCFSA. Your spouse, dependents and adult children through age 26 can use it, too.
- Increased Take-Home Pay: Because an FSA reduces your tax burden, it can ultimately increase your take-home pay. An employee making $60,000 annually with a 30-percent tax rate would net $40,145 after taxes and the maximum $2,650 FSA contribution for 2018, according to WageWorks, a provider of consumer-directed benefits. The same worker would take home $795 less if he paid $2,650 in medical expenses without the FSA plan.
- Immediate Availability of Funds: You specify your FSA contribution in the beginning of the year, and it’s taken out gradually, with each paycheck. But the full pledged amount is available to you immediately.
- Debit Card: Many FSAs are connected to debit cards you can use to pay for expenses directly.
Related: 7 Surprising Things an FSA Covers
Cons of Flexible Spending Accounts
FSA requirements create some drawbacks to consider when deciding whether an FSA is right for you and your family. Here are some of the negative aspects of these accounts:
- Limitations: Employees are limited to a maximum contribution of $2,600 per year in 2017 and $2,650 in 2018. But a working spouse can also contribute the maximum through his employer’s FSA.
- Expiration: Generally, you must use the money in your FSA within the plan year. But some employers offer a grace period of up to two and a half months, or they might allow up to $500 to be rolled over to the next year.
- Lose Your Job, Lose Your Benefits: FSAs are tied to your employer, so you lose the benefit if you leave your employer.
- Limited Enrollment Period: You must sign up for an FSA during your employer’s open enrollment period. Missing the deadline means you’re out of luck until next year unless you experience a qualifying life event such as a marriage, birth or adoption.
- You Can’t Alter Your Contribution Amount: Unless you experience a qualifying event, the contribution you state at the beginning of your annual plan cannot be changed until the next year.
- No Tax Write-Offs: You can’t deduct FSA-reimbursed medical expenses when you file your tax return.
Although you do have to “use it or lose it” when it comes to your FSA contributions, the accounts can help you save money. You might want to consider enrolling in one of these plans so you and your family can reap the benefits.
Ashley Eneriz contributed to the reporting for this article.