FSA as a Savings Tool?
Budgeting and saving are two basic ingredients to a solid financial plan. What is often overlooked during these financial discussions is an employer-provided benefit: Flexible Savings Accounts (FSAs). An FSA allows employees to use pretax dollars to fund eligible healthcare related expenses not covered by a health plan.
Why You Should Use/Care About FSAs
Two words: big savings. Having an FSA is like getting a 30% discount on healthcare and dependent care costs (free money people!). Depending on your expenses and tax bracket, you can save hundreds to thousands of dollars on things like dental work and prescriptions, as well as on something we normally never get a break on (and pay out the wazoo for): childcare and care for other dependents.
FSAFEDs, the official FSA site for US Federal employees, says that an FSA can save you from 20% to more than 40% you would normally pay out-of-pocket for these costs, with the average person saving about 30% each year. That's because the FSA reduces how much you have to pay in taxes each year (so, more money for you and less for Uncle Sam).
What Can You Save On?
Before we go any further - what qualifies as eligible healthcare and dependent care costs? An awful lot, but, as is typical with tax breaks, many rules and exceptions, and new changes each year add to the confusion.
Dependent Care FSA: The most important rule for being eligible for Dependent Care FSA is that you and your spouse are gainfully employed since the FSA is intended to help people with work-related dependent care costs. The dependent can be any child under age 13 or any dependent you claim on your tax return who lives with you and is not capable of self-care (including parents and siblings). Day care centers and summer camps are examples of eligible expenses; babysitting at night (when you are not working) and kindergarten are not.
Healthcare FSA: Healthcare expense eligibility is more complex. Over-the-Counter medications are only allowed when purchased with a doctor's prescription (except for insulin) while Over-the-Counter medical devices (bandages, crutches, eyeglass repair kits) are allowable. Common expenses that you can pay for with a Healthcare FSA include: medical and dental co-pays, prescription medicine, eyeglasses and vision exams, and orthodontia. You'll want to consult your company's FSA brochure to check for the full list of eligible expenses.
How Do They Work?
Basically, an FSA lets you set aside money for healthcare expenses and dependent care costs you think you'll have next year. They money comes out of your paycheck before taxes are deducted, which leads to all those big savings.
You have to decide during the enrollment period, which is typically in the fall, how much you think you'll need for the entire next year's health and dependent care costs – so get ready to put on your estimating (or psychic prediction) hat.
The most you can put into the FSA account is up to $2,500 in the Health Care FSA and up to $5,000 in the Dependent Care one. However, this limit is determined by the IRS and will change based on cost-of-living adjustments.
After you enroll, the money you set aside will be spread out over the next year starting in January and will be automatically deducted from each paycheck. You have 14.5 months (which includes a 2.5 month grace period) to use the money in your FSA accounts. And this year, the IRS modified the "use it or lose it" rule to allow for a $500 rollover.
Another neat feature is even if the FSA contributions to date aren't enough to cover an expense, you can still get reimbursed for it, as long as your election amount for the year is enough to cover the expense. For example, if in February you have a large $3,000 medical bill but only $50 deducted so far, you can still submit a claim for the full bill in February.
What's the Catch?
Sounds great – right? But what's the catch? Well, it's a biggie: Any money you don't use up for the year is forfeited, which makes enrolling in an FSA a bit tricky and a reason lots of people shy away from it. This is otherwise called the "use it or lose it" rule. You want to set aside enough to cover all or most of your eligible expenses so you get the most tax savings, but also don't want to set aside too much and end up losing what you set aside.
The easiest way to figure out how much to put aside is to use an FSA Savings Calculator. The tool can help you figure this all out: whether the Health Care FSA is worth it, what expenses you expect to have, and how much to save. You can also look back on previous medical expenses and use those as the amounts during your calculations. And finally, go see your doctor and dentist. With a full workup now, your doctors can help you plan for any elective healthcare that you can budget for (i.e. a crown or root canal).
Now get to saving!