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Flexible Spending Accounts: What, How, and Why
By Kelly Whelan
Flexible spending accounts are offered by many employers as a benefit to their employees. While many people have access to a flexible spending account, or FSA, not everyone understands what a FSA is or utilizes them to their full advantage. There are a number of benefits to FSAs, but first let's break down what they are.
What is a Flexible Spending Account?
A flexible spending account is an account where you contribute money for medical or dependent care expenses for the year. Contributions and withdrawals are not taxed. This allows you to spend pre-tax dollars which can save you money. For instance, if you're in the 25% bracket and pay 7.65% in Social Security/Medicare taxes, $1,000 contributed pre-tax into an FSA would be the equivalent of $673.50 post-tax.
There are two types of FSAs- dependent care FSA and a healthcare FSA.
Dependent FSAs can help you pay for care costs associated with dependents. This includes children 13 and under, adults and children who are physically or mentally in need of care, and seniors who need adult day care. The costs you can cover include the cost of dependent care such as daycare and summer day camps among others.
Healthcare FSAs can help you cover healthcare costs. This includes deductibles, prescription costs, copays, and any other medical costs. Additionally, healthcare FSAs can also be used to cover the cost of prescription eyeglasses or sunglasses, contact lenses, and dental and orthodontia costs.
Don't confuse healthcare FSAs with Health Savings Accounts (also known as an HSA). An HSA is only available with a high-deductible health plan. A healthcare FSA is available with more typical healthcare plans. To make it even more confusing, if you have an HSA and a high-deductible health plan you can also have a 'limited purpose FSA' which allows you to cover only costs associated with dental and vision care.
What are the FSA limits?
For 2018, healthcare FSA limits are capped at $2,650 per employee. If you and your spouse or partner have access to healthcare FSAs you can both contribute to your own FSA. Employers may also contribute funds to your healthcare FSA.
For 2018, dependent care FSA limits are capped at $5,000 per family.
How can you use a FSA?
The good news is, most large- to medium-sized companies offer FSAs as a benefit to employees. Smaller companies are less likely to offer FSA options. If your company does not offer FSAs, it can be helpful to let your human resources department or your employer know that it would be of interest to you.
If your company offers an FSA, you will be able to sign up for regular paycheck deductions during your open enrollment period or whenever you make benefit changes (such as after the birth or adoption of a child).
It's important to read the rules surrounding what you can use your FSA account for and estimate your expenses for the year. For most people, a healthcare FSA makes sense since deductibles and healthcare costs are rising. If you already pay for dependent care, a dependent care FSA may also make financial sense. For dependent care, check to see if you are eligible for the Federal child and dependent care tax credit. Keep in mind that to use the dependent care FSA, any parents or guardians who live in the family home must be actively employed, looking for work, or a full-time student.
Lastly, FSAs get a bad reputation for having a 'use it or lose it' clause. However, plans vary, so be sure to read the fine print on your plan. In many cases you can use up the last of those funds to pay for more expensive items like end of year eyeglasses, or you can make a large payment to your orthodontist.
Why consider a FSA?
The main reason? You'll save money. The contributions and withdrawals you make are tax-free, so you save money by not paying taxes on funds you would have used to cover medical costs anyway.
Those tax advantages aren't the only reason to use a FSA. For healthcare FSAs, you can use your funds upfront — meaning you can spend the money you plan to contribute anytime. For example, if you have an emergency room visit and owe $800 in January, but have only contributed $200 to your FSA so far you can still take out the $800 you need. It's important to note, however, that dependent care FSAs do not offer this option.
Dependent care accounts also go through the end of your plan's year. That means even if you're let go or fired, you will still have access to the funds you have already created.