Flexible Spending Accounts

Does your employer offer Flexible Spending Accounts (FSA’s)?  If they do, are you participating?  If you aren’t you should!  Let me explain what they are, and why they are beneficial:

What is a Flexible Spending Account? 

An FSA is an employer sponsored account that allows you to be reimbursed for qualified expenses on a pre-tax basis.

What are the different types of Flexible Spending Accounts?

FSA’s typically fall into two categories: Health Spending Accounts, and Dependent Care Spending Accounts. 

How do Flexible Spending Accounts work?

Signing up:  Enrollment in FSA’s is limited to the beginning of each calendar year.  Prior to the start of the calendar year, there is a period of open enrollment, during which time you can sign up to start your FSA.  Aside from this annual open enrollment period, you can only start an FSA if you have experienced a qualifying life event (such as marriage, birth of a child, divorce, death of a spouse, etc).

At the time of enrollment, you determine the annual amount of funds that you want held from your wages pre-tax to be applied to your FSA (For Health FSA’s the maximum limit is currently $2,500/year, and for Dependent Care FSA’s the maximum limit is currently $5,000/year).  The amount of the allocation that you choose will then be divided by your pay frequency (if you are paid weekly your allocation will be divided by 52,  if you are paid bi-weekly your allocation will be divided by 26, etc.).  This amount will then be deducted from your wages pre-tax, and applied to your FSA.

When you have a qualifying expense, you then submit a claim and documentation that the claim was paid out of pocket, and you are reimbursed from your FSA.

What expenses are considered qualifying expenses?

Dependent Care FSA:  Any expense incurred for the care of a dependent child under the age of 13, or a child of any age with a medical or mental challenge that causes them to be incapable of self-care, or care of a dependent adult in adult daycare.  In order to be considered a qualifying expense, this care must enable you to work, and the person receiving the care must be claimed as a dependent on your tax returns.

Examples: Daycare for child(ren), adult daycare, in home care of dependent

Health FSA:  Any medical expense that you incur that is not covered by your health insurance, and is an acceptable medical expense as defined by the Internal Revenue Service, may be counted.

Examples: Co-pays paid to doctors, dentists, surgeons, hospital fees, hearing aids, wheelchairs, prescription drugs (for a more detailed list, please see the IRS link above)

How do you know how much money to put into your FSA?

This is an important step to think about, because FSA’s operate on a “Use it, or Lose it” methodology.  If you contribute more to your FSA than you use, any remaining funds are lost.  It’s important to carefully consider your needs for the upcoming year before deciding on your allotment.

To determine the amount that you want to allocate to your FSA, make a list of all expected allowable deductions for you and your dependents as well as the costs associated with each.  Use this to gauge how much money you want to contribute to your FSA.  Always err on the side of caution, and if in doubt go with a lower amount.  You don’t want to lose funds by taking advantage of this program.

Dependent Care Example:  If you pay $100/week for your 4-year-old to attend daycare while you work, you would calculate out your annual expense as $100x52, or $5,200.  In this case you would want to take the full $5,000 allotment that you are allowed for a Dependent Care FSA.

However, if your daycare expense is subject to change because your child will be attending school, you’ll want to take that into account, and reduce your allocation accordingly.

Health Example:  If you pay $50/month in copays for prescription drugs, you would calculate your annual expense as $50x12, or $600.  You may know that you’ll also have other expenses for the year as well, like prescription glasses for your child, or dental visits that aren’t covered by your insurance.  You would then estimate those expenses and add them to your known expenses, and use that as a basis when deciding how much to allocate to your Health FSA.

How do you save money by having these expenses paid via FSA?

Let’s say that you have a household income of $50,000, and you pay $5,000 for daycare.  Of your earned $50,000, 25% [$12,500] goes to tax obligation (Federal Income Tax, Social Security, and State and Local Income Tax).  That brings your earnings down to $37,500, now subtract the $5,000 that you  pay for daycare, and you’re now at $32,500.

Using the same numbers, and allocating $5,000 to a Dependent Care FSA.  Your income is reduced to $45,000 by allocating $5,000 pre-tax to the FSA, your 25% tax allocation is now $11,250.  This leaves you with $33,750.  By allocating to an FSA, you saved $1,250!!

Now, when the open enrollment period for FSA’s comes around this fall, make sure you take advantage, and remember to err on the conservative side when you are estimating how much you want to allocate.  It doesn’t pay to lose money by over allocating.