A Flexible Spending Account? I’d been working hard at saving the world in my current social work position when I first heard of the Health Flexible Spending Account (FSA) benefit available through my job.
One whole year had gone by since I started this job, and using an FSA for saving money on health care wasn’t even on my radar.
But as my personal focus on financial independence and boosting my savings for retirement crystalized, I decided to find out more about this money-saving, tax optimization tool.
Here is what I learned . . .
What is a Flexible Spending Account?
Actually, FSAs are not accounts, but tax arrangements. A Flexible Spending Arrangement allows your employer to set aside some of your pre-tax earnings to be spent on qualified health and/or dependent care expenses.
The portion of your earned income that is funneled into your FSA completely bypasses federal income tax, Social Security tax, and Medicare tax.
This allows you to pay for qualified out-of-pocket medical expenses or dependent care expenses with pre-tax rather than after-tax income.
What plans are available within the Flexible Spending Account?
An FSA is only an option if your employer offers it as part of your employee benefit package.
There are two types of FSA plans, the Health FSA and the Dependent Care Assistance Plan.
The Health FSA covers medical, dental and vision expenses that your regular health insurance doesn’t.
We’re talking about co-pays, deductibles, glasses, hearing aids, medical equipment, smoking cessation programs, over-the-counter medications (with a prescription) and more.
The Dependent Care Assistance Plan covers childcare and afterschool program expenses or elder care so that you and your spouse can go to work.
How much can you contribute to a Flexible Spending Account?
You get to decide how much of your income you want to have set aside each year, within the plan’s limits. This is your annual election amount.
You have to stay within the plan’s minimum and maximun annual election amounts.
The IRS sets the maximum contribution limits for the Health FSA, which is indexed for inflation and may change from year to year.
For 2018, the maximum annual election amount for a Health FSA is $2,650 (up $50 from 2017).
The Dependent Care Assistance Plan maximum for 2018 is $5,000 ($2,500 if you are married and file separate tax returns).
If your spouse is a full-time student or disabled and unable to work, the maximum annual election for the Dependent Care Assistance Plan is $3,000 for one child, or $5,000 for two or more children.
When can you enroll in a Flexible Spending Account?
If your employer offers this benefit, you can enroll upon being hired, during the annual enrollment period, or if you have a qualifying event.
You may have a qualifying event if you get married, divorced, your spouse passes away, you have a baby or adopt one, etc., but you have to enroll within a set amount of time.
What are the benefits of a Flexible Spending Account?
You can gain substantial tax savings with an FSA.
Contributions to your FSA are deducted from from your income before taxes, which means you can save 30-40% on the dollar (depending on your tax bracket).
To illustrate this, consider that you must earn $520 in order to take home $400 after taxes.
By using a Flexible Spending Account, you only need to earn $400 to cover qualified expenses.
I used an online calculator to figure out how much I would save by contributing the maximum to my Health FSA in 2018, and it was about $782.
You can boost your savings rate with an FSA.
Every dollar you save by paying for medical expenses or dependent care costs with pre-tax money gives you more freedom to reach your savings goals.
Using a simple interest calculator, I figured my $782 savings from funding my Health FSA would nearly double at 6% interest over 10 years.
This is not to say that the money in your FSA can be saved for more than one year – in most cases it can’t.
The FSA is not a savings account.
It is a benefit provided by your employer that allows you to use pre-tax earnings to cover your annual dependent care expenses or out-of-pocket medical expenses.
But if I take the amount of my projected savings and set aside the same amount in after-tax funds into my brokerage account, it will help boost my savings for my future retirement.
I learned to think outside of the box when it comes to growing my retirement next egg after I discovered the Financially Independent Retire Early (FIRE) community.
Every little bit that I can add to my savings helps!
Is there a downside to Flexible Spending Accounts?
Yes, it’s a use it or lose it proposition.
You have to plan very carefully, because if you don’t use up all the pre-tax funds in your FSA within the calendar year, you basically lose them forever – the money’s gone!
I was very leary about this when I signed up for an FSA last year. I contributed $500 and it was all used up before the year was over.
I could have contributed more.
For 2018, I decided to contribute the max to my Health FSA. I carefully reviewed what we expected to be spending on out-of-pocket health care costs.
Hopefully I’ve estimated correctly, and we’ll use up all of the pre-tax money set aside in my FSA.
My employer does allow for a roll-over of $500 per year, so there’s that. But if I underspend by $600, I’ll lose that other $100 since only $500 carries over.
Is it worth it to contribute to a Flexible Spending Account?
Yes, I think it is, at least for my family. It will free up more funds that I can use to catch up on retirement savings.
We don’t have childcare expenses, but we do expect to have out-of-pocket health care costs that aren’t covered by insurance.
We could set up sinking funds to save for out-of-pocket health expenses, but we’ll get more bang for our buck using pre-tax dollars to pay for those expenses.
I think it will be important to re-evaluate participation in my FSA each year. For years that my family expects to have less health care costs, I’ll contribute less to the FSA.
I will definitely strive to be sure I’ve used all my FSA funds before the year’s end.
October, November, and December are good months to use up any funds left in your Flexible Savings Account!
Question: Do you have access to a Flexible Savings Account at your job? Have you used it and have you found it easy or difficult to make sure you use up all the funds?