The Basics of a Medical FSA
The government, and more specifically the IRS, offers many options for US citizens to pay for healthcare in a way that provides tax advantages to them. In a way, the IRS is saying that it doesn’t want to penalize people for having to spend money to take care of themselves. To start with, employee-made payments for health care premiums are tax-free. The government also created several tax-advantaged accounts to help smooth spending and to allow savings for future expenses. These accounts are called the FSA and the HSA.
For this article, we will be focusing solely on the FSA and even more specifically on the Medical Flexible Spending Account. All of these accounts are fundamentally different in what they offer and how employers treat them so let’s take it one step at a time, shall we?
The FSA is an account set up through your cafeteria health care plan from your employer. In addition to selecting your health care provider (such as Blue Cross Blue Shield), many people have access to creating the FSA account as an optional add-on.
The FSA is an amount of money (up to $2550) that you can contribute to your healthcare spending on a pre-tax basis. Typically you will pay equal “installments” on this amount from each paycheck throughout the year. What makes the FSA unique, however, is that you can use all of the money you elected from the very first day of the enrollment year. You are also allowed to use these funds for not only yourself but also any dependents that you claim on your taxes each year.
How does this work?
Your employer often gives you a debit-style card with the full amount pre-loaded on the card at the beginning of the year. You are free to use it for any qualified expense, from day one, regardless of how much you have paid towards it. You are often responsible for keeping receipts and providing records at the end of the year on all of your purchases to ensure that they are covered expenses.
Some other employers have a system of reimbursements used instead of a card, but the card option is the most common case.
What’s the Catch?
You may be thinking at this point that the FSA sounds like a win-win for everyone, right? After all, you get to save tax money on expenses that you would be paying for anyway! The catch is that any money left in your FSA at the end of the year is typically permanently lost*. Yes, it is a use-it-or-lose-it-style account. This doesn’t mean that the tax advantages aren’t worthwhile, it just means that you as the consumer must be very careful in how much you elect to place in your FSA at the beginning of the year.
What this does mean is that if you have extremely routine medical expenses or that you anticipate an extremely high medical bill during the next year you will be able to set up an FSA to help mitigate some of those costs.
If you have a family of four in which a couple of people are on regular medications, and you also have a child expecting to have dental work such as wisdom tooth extraction during the year, your expenses could quickly start to add up. Being able to predict this number by doing a lot of proper planning is important.
*Very recently the IRS decided to allow employers the choice of offering employees the ability to EITHER roll-over $500 of their FSA to the next year OR take an additional 2.5 months to use the money from the prior calendar year. These options are by no means a required benefit so please check with your employer.
What Can I spend the FSA Money On?
Although you CAN’T pay health insurance premiums with your FSA (they are already considered pre-tax), you can pay for almost anything else medically-related with your account.
Anytime you are involved with medical care from a doctor or hospital you are allowed to use your account to pay your deductibles and copayments. You are also authorized to pay for any new or recurring prescriptions. This could be good news for people with a higher deductible, injury-prone children, or those with chronic conditions requiring constant care.
This category is ordinarily where the majority of the dollars from your FSA will go.
There are a ton of over-the-counter items that are eligible, but one important thing to note is that any “medicine” such aspirin, cold remedies, etc. MUST have a prescription from your doctor to count. I guess this is to curtail employees from simply skipping the doctor and self-medicating?
Here is a big list of some common items (definitely not inclusive of everything) that ARE eligible without any prescription:
- Baby sunscreen
- Breast Pumps and Accessories
- Blood Pressure Monitors
- Contact Lens Solutions
- First Aid Kits
- Denture Accessories
- Diabetes Care Accessories
- Lip Balm
- Nasal Spray
- Pregnancy Tests
- Prenatal Vitamins
- Show inserts
So you can see that there are lots of items that people spend money on all the time that are eligible for FSA spending. A likely scenario, even for a completely healthy individual or family, could include $500 in their Flexible Spending Account just to pay for some of these common expenses throughout the year. This way they are TAX-FREE!!
For a full list of eligible items, please check out the list of eligible medical expenses from the IRS.
Advantages of an FSA
So it’s pretty clear that the main benefit of an FSA is that they are created to save employees money on their taxes.
If you elected to contribute the entire amount ($2550) and you are in the 25% tax bracket, then you would be saving $640 a year in taxes. Not too shabby.
Another main advantage is that you have access to this money from day one of your enrollment period. This can help when there is an unexpected cost right from the jump.
Even if you only elected a small amount to save on some common items throughout the year, it could be a no-brainer to set up an account.
Disadvantages of an FSA
The apparent downside to this kind of account is that if you elect to contribute more than you use then some very real money could be lost that would completely wipe out any tax savings you might have enjoyed by contributing. It is critical that you do your due diligence when planning your election amount so that you won’t be stuck at the end of the year buying a pallet of sunscreen to use up all of your money!
Is an FSA Right for Me?
Deciding if an FSA is right for you just comes down to the amount of expenses that you have in a year and what your goals are for the account. If you are typically spending way over $2550 during a year on medical expenses for things that your insurance doesn’t cover then, you would want to seriously consider enrolling in this type of an account to save money.
I personally think that for the budget-minded and frugally-focused individuals out there it would make perfect sense to at least contribute a few hundred bucks to use for bandages, sunscreen, and contact solution. It’s a win-win!
Do you have an FSA? Another type of medical savings or tax-advantaged account? Let me know what works for you!