What is a Flexible Spending Account and Should You Use One?

Health insurance and healthcare are some of the most complicated and stressful aspects of most Americans financial lives.

It can be difficult to know what your insurance covers, which plan to choose, and what doctors to visit.

Above all, it’s can be hard to afford the care that you need.

To help people afford health care, the government has set up a number of things that help people save money for healthcare purposes.

One of these is the Flexible Spending Account (FSA).

What is an FSA?

An FSA is a special type of account that you can use to save money that will later be used to cover health care costs.

The money in the account can be used only for health care, but in exchange, you do not pay income tax on the contributions you make to an FSA.

For example, if you have a taxable income of $50,000, and place $1,000 in your FSA, you will only report a taxable income of $49,000 when you file your taxes. This can help you save money when you later use the funds in the FSA to pay for health care.

You may contribute no more than $2,650 per year to your FSA, so there is a limit on how much you can save in taxes.

Pros & Cons of an FSA

Pros Cons
  • Reduces taxable income because it is funded with pre-tax money
  • Can be for a wide range of out-of-pocket health care or dependent care expenses
  • Easily accessible via linked debit cards
  • Account funds do not roll over to the next year
  • Annual contributions are subject to a maximum limit
  • If you leave your job, the FSA benefit is lost
  • Must be opened during your employer's open enrollment period
  • How Do You Fund an FSA?

    FSAs can be funded in one of two ways.

    1. Employer contributions

    Some employers choose to deposit money into their employee’s FSA as an employee benefit.

    You can see this as free money that you can use for health care costs.

    2. Employee contributions

    You can elect to have a specific amount of money deducted from each paycheck and deposited to your FSA.

    Usually, you make the decision on how much to deposit at the start of the year, and equal amounts are deducted from each paycheck you receive that year.

    How Do You Use the Money in an FSA?

    When you sign up for an FSA, your FSA provider will send you a special debit card.

    You can use that debit card at qualified locations to use the funds in your FSA, much like you would with a checking account.

    For example, when you visit the doctor, you generally need to pay a copay for the service you receive.

    Rather than paying with cash or a credit card, you can pay with your FSA debit card.

    The money will be deducted directly from your FSA. There are no paperwork or reimbursement forms to fill out, everything is automatic.

    Make Sure to Use All the Money in Your FSA

    One of the biggest downsides on FSA is that the money in the account generally does not roll over year-to-year.

    If you deposit too much money into your FSA but don’t use it, you’ll lose the leftover balance at the end of the year.

    Your employer may allow a grace period of up to 2½ months where you can use the remaining money in your FSA, but your employer is not obligated to. Once this period expires, the remaining funds disappear.

    Alternatively, your employer may allow you to carry up to $500 over from year-to-year. Any funds in excess of $500 are surrendered.

    Your employer may offer one of these benefits, but not both.

    Because both of these options are limited, do your best to deposit only as much as you’re sure to use towards medical expenses.

    What Can an FSA Be Used For?

    The money in an FSA can be used for all sorts of medical expenses.

    The IRS provides a few guidelines on what kind of expenses qualify, but it’s hard to know exactly what you’re allowed to use FSA funds on.

    In general, anything that requires a prescription to purchase is eligible.

    You can also use FSA funds to pay for services at doctor’s offices. Some other things that you can use FSA funds on include:

    • Acupuncture
    • Treatment for Alcoholism
    • Ambulance and emergency health services
    • Crutches
    • Psychological treatment
    • Smoking cessation programs
    • Birth control
    • Pregnancy tests
    • Bandages
    • Chiropractors
    • Dental care
    • Diabetic supplies
    • Eye examinations

    Almost anything that relates to your health may qualify as a medical expense for your FSA.

    Make sure to keep your receipts and supporting documentation in case your expenses are audited and don’t be afraid to consult a professional to find out whether a specific expense will qualify.

    Can You Get An FSA Without Having Medical Insurance Through Your Employer?

    Yes. Even if you elect to not enroll in your employer's health insurance plan, you are still eligible to open up an FSA. This may be a good option if you are covered under your spouse or your parents.

    However, the only way for you to open up an FSA is if your employer offers health insurance in general. Again, that doesn’t mean that you have to enroll in their medical insurance plan -- it just means your employer has to pay into medical insurance (that offers an FSA option), to provide to their employees if they choose to enroll.

    If you are still covered by your parents’ insurance plan, you could be eligible for the FSA offered by their employers.

    If you have a health care plan through a health care marketplace, you are also ineligible for an FSA. Instead, you can open a Health Savings Account (HSA).

    Don’t Confuse Your FSA for an HSA

    Though their acronyms are similar, it is important to make sure that you don’t confuse FSAs with HSAs.

    Both are used for health care expenses, but they have very different features.

    For one, anyone covered by an employer insurance plan that offers an FSA can open one.

    Rule to open an HSA

    To open an HSA, you must have a high-deductible health plan (HDHP).

    If you have insurance that does not qualify as an HDHP, you cannot open an HSA.

    However, if you have an HDHP that isn’t through an employer, you can open an HSA anyway.

    Funds roll over

    The other major difference is that the money in an HSA rolls over from year to year.

    You can deposit up to $3,450 per year to an HSA if you are single, and double that if you are married.

    If you don’t use all the money in the HSA by the end of the year, the remaining amount carries over to the next year.

    This means that HSAs are great for long-term health care savings. FSAs can only be used to save for health care expenses for the current year.

    FSA vs. HSA

    FSA HSA
    • Anyone covered by an employer health insurance plan can open an FSA
    • If you do not use all of the money in your FSA by the end of the year, it does not carry over
    • Lower employee-contribution limits
    • Employees have complete access to their FSA funds, regardless if they contributed their full annual election amount
    • You must decide the total amount you want to contribute at the beginning of the year
    • Employees are eligible only if they have a high deductible health plan
    • The money in an HSA carries over from year-to-year
    • Higher employee-contribution limits
    • Employees only have access to what they currently have contributed to their HSA at that time
    • You can change your contribution amount, as long as it does not exceed the contribution limit

    How Much Should You Contribute to an FSA?

    How much you should contribute to an FSA is a difficult question to answer, because the answer depends on your medical situation.

    The goal when deciding how much to contribute should be to contribute exactly as much as you will spend on medical expenses that year.

    If you are able to predict that you will spend exactly $789.28 on medical expenses this year, you should contribute exactly $789.28 this year.

    Of course, no one can predict their medical expenses that accurately. Prices for products and services can change, or you might have an accident that incurs significant costs.

    Instead, you have to predict what is likely to happen in the coming year. If you’re recovering from something and expect to visit the doctor a lot, contribute more.

    If you’re healthy and don’t need to visit the doctor or buy medicine often, contribute less.

    At a minimum, you probably want to contribute enough to cover the cost of an annual check-up and a dentist visit or two.

    If your FSA allows a carryover from year-to-year, you could contribute at least that much and let the remainder roll over. That will give you small emergency fund for medical problems.

    Should You Use an FSA?

    If your employer offers an FSA, there’s generally no reason to not make use of it, but whether or not it’s worth the effort is up to you.

    To effectively use an FSA, you need to be able to predict your medical expenses for the year, at least to an extent.

    If you overestimate your expenses, you could lose money as the remaining balance in your account is surrendered. If you underestimate your expenses, you won’t get the full benefit of the account.

    If you generally have a lot of medical problems, opening an FSA is an easy choice.

    This is doubly true if you spend enough each year that you can max out your FSA and then spend all the money you contributed.

    If you’re generally healthy, opening an FSA might be more effort than it is worth.

    What’s right for you depends on how well you can predict your health, and how much effort you’re willing to put into making the prediction.

    Conclusion

    FSAs are a good way to save on medical expenses, but they require that you predict how much you’ll spend on health care before you actually spend the money.

    If you’re able to predict accurately, you’ll save on your taxes.

    If you predict poorly, you’ll either lose money by losing the remaining balance of the account or fail the get the full benefit available to you.

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