A flexible spending account is a special account that allows you to set money aside, tax-free, for out-of-pocket medical expenses and dependent care costs. The healthcare FSA can be used for copayments, deductibles, medical equipment and some prescriptions. The Dependent Care FSA can be used to cover eligible expenses for children, disabled spouses and elderly parents.
Pros of Flexible Spending Accounts
If you anticipate incurring a lot of medical expenses in the next year or must care for a dependent, then an FSA might be a good fit for you. Here are some of the perks:
- Tax Savings: Employees contribute to their FSA through payroll deductions, which means the money is taken out before taxes. Therefore, your taxable income is lowered and can reduce the amount of taxes paid.
- Medical Savings: Although health insurance can cover many expenses, it sometimes doesn’t cover auxiliary medical costs, such as over-the-counter prescriptions, travel vaccines and preventative tests — which the money in your FSA can be used for.
- Increased Take-Home Pay: Because an FSA allows you to save on taxes, that can ultimately increase how much money you take home at the end of the year. WageWorks, a leading provider of consumer-directed benefits for pretax commuter and health accounts, shows that an employee making $60,000 a year with a 30-percent tax rate would ultimately take home $40,180 after taxes and maximum FSA contributions. However, the same worker would only take home $39,400 if he paid for $2,600 in medical expenses without the FSA plan. That’s a $780 increase in take-home pay.
- Immediate Availability of Funds: You pledge how much you want to put in your FSA in the beginning of the year, and that is taken out gradually with each paycheck. However, the full pledged amount is available to you immediately.
- Debit Card: Many FSAs are connected to debit cards that you can use to pay for expenses directly.
Cons of Flexible Spending Accounts
Some drawbacks do exist for using an FSA, so make sure you understand them. Knowing the disadvantages to such an account will help you better decide whether it’s right for you and your family. Here are some of the negative aspects of an FSA:
- Limitations: Employees are limited to a maximum contribution of $2,550 per year. However, a working spouse can also contribute $2,550 to his own health FSA through his employer.
- Expiration: You’re generally required to use the money in your FSA within the plan year. However, some employers might offer a grace period of up to two and a half months to use your FSA, 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 if you leave your employer, you can’t maintain this benefit.
- Limited Enrollment Period: You must sign up for an FSA during your employer’s open enrollment period. If you miss the deadline, you’re out of luck until next year unless you have a qualified family status change, such as a marriage, birth or adoption.
- No Tax Write-Offs: If your health FSA reimburses a medical expense, you can’t write off the medical expense when you file for taxes. Similarly, if you use the Dependent Care FSA, then you can’t receive the Dependent Care Tax Credit.
Although you do have to “use it or lose it” when it comes to your FSA contributions, the accounts can save you money overall. Someone who pays 30 percent in federal and state taxes could save $765 per year if he contributes and uses the maximum FSA contributions.