Your Essential Guide to Flexible Spending Accounts

flexible spending account

In February 2015, my wife gave birth to our first child. But instead of paying the huge bill out of pocket, our checking account balance dropped by only a few hundred dollars. The rest was covered by the flexible spending account (FSA) I contributed to monthly.

Not only did we avoid draining our bank account, but the money I contributed to the FSA was made pre-tax, giving us hundreds of dollars in tax savings every year.

If you have consistent health care needs or a big health care event coming up, find out why you should consider setting up an FSA today.

What is a flexible spending account?

Sixty-five percent of employers offer FSAs, according to the Society for Human Resource Management. Designed to help you pay the cost of health care, an FSA covers a wide range of eligible medical expenses (more on those expenses later).

There are some ineligible expenses, though, so make sure you double-check before trying to use your funds.

How flexible spending accounts work

You can set up an FSA during your employer’s open enrollment period for the next year and determine how much you want in the account up to that year’s limit. In 2018, you’ll be able to contribute up to $2,650 for the year.

On Jan. 1 the following year, you’ll get the full amount in your FSA to spend on eligible expenses. Then, your employer will deduct the amount from your paychecks throughout the year before taxes.

For example, if you want $2,400 in your FSA, your employer will deduct the following from each paycheck, depending on how often you get paid:

  • $200 if you’re paid monthly
  • $100 if you’re paid semimonthly
  • $92.31 if you’re paid biweekly
  • $46.15 if you’re paid weekly

The benefit you get comes directly from the tax savings. For example, if you contribute $2,400 throughout the year and have an effective tax rate of 20 percent, you’ll save $480 in taxes that year.

$2,400 x 20 percent = $480

And if you’re lucky, your employer also will contribute to your FSA, giving you even more savings. For instance, my employer at the time my son was born matched 100 percent of my contributions up to $1,000.

I set my FSA amount at $2,500, so I contributed $1,500 throughout the year, and my employer contributed the other $1,000.

How to use your flexible spending account funds

You’ll typically get a debit card in the mail that’s tied to your FSA, making it easy to use your FSA money. That said, you also can pay for the medical costs out of pocket and submit a request for reimbursement.

To get the reimbursement, you’ll usually scan and upload or fax a copy of your receipt that shows the date of the service or purchase, a description of the service or product, and the cost.

Additionally, you might get a request to substantiate certain debit card purchases to make sure they’re eligible. The same process applies as if you were requesting a reimbursement.

Qualified health care expenses

Some of the eligible costs you can cover with your FSA money include:

  • Doctor visit copays
  • Doctor and specialist procedures
  • Dental exams and procedures
  • Vision exams, glasses, and contacts
  • Prescription medicines
  • Some over-the-counter medicines
  • Physical therapy
  • Psychiatric care
  • Hospital stays and services

You can find a complete list of eligible expenses on the Internal Revenue Service (IRS) website.

Use it or lose it

The main drawback to FSAs is the fact that you have to use the account balance by the end of the year. Otherwise, you lose it.

To mitigate this problem, employers can (but are not required to) offer one of two options:

  1. You can carry over up to $500 to the following year.
  2. You can have a grace period of up to two and a half months after the year is over to count medical expenses toward the previous year.

If you’re coming up on the end of the year and are afraid you’ll lose your FSA funds, consider prepaying for a service you regularly use, such as chiropractic adjustments or physical therapy. You also can check out the FSA Store, where you can find thousands of FSA-approved products.

You can’t take it with you

If you quit your job or are terminated, the FSA funds don’t follow you to your new employer. That said, if you end up using all the funds before the end of the year and are terminated or quit, you don’t have to pay back the remainder in most cases.

That’s what happened to me in 2015. I received $2,500 in my FSA in January, my son was born in February, and I drained the account to pay the hospital bill. Then, I left the company in March without needing to make any more contributions to the FSA.

Some FSA plans might require that your remaining contributions be taken from your final paycheck, however, so be sure to check with your employer.

Flexible spending account vs. health savings account

Another option to consider as you look for ways to save on health care costs is a health savings account (HSA). An HSA functions like a normal savings or investment account. You can contribute to it regularly or not at all.

Unlike an FSA, an HSA comes with the following benefits:

  • You can take it with you wherever you go.
  • You’re not required to use your funds within a set time frame.
  • You can invest your HSA funds to compound your savings once you have at least $2,000.
  • You can use it to save for health care costs in retirement.
  • In 2018, you can contribute up to $3,450 if you’re single or up to $6,900 if you have a family.

Some employers also make contributions to HSA accounts as a benefit.

That said, not everyone can contribute to an HSA. To qualify, you have to have a high-deductible health plan (HDHP), which means your health insurance must have a deductible of at least $1,350 on a self-only plan or $2,700 on a family plan.

You also can’t open an HSA if someone else can claim you as a dependent on their tax return or if you’re covered under a secondary health insurance plan that doesn’t meet the HDHP minimums.

Is a flexible spending account right for you?

You can’t have both an FSA and an HSA, but you should seriously consider getting one or the other if you qualify.

The FSA is particularly helpful if you don’t qualify for an HSA, but you need to make sure you use the funds each year. So, if you don’t visit the doctor often, it might not be worth it.

If you do qualify for an HSA, though, you’ll be better off knowing you can take your money wherever you go and that there’s no risk of forfeiture. The investment element of an HSA can be risky, but it also can offer tax-free returns. Plus, you don’t have to invest your money if you don’t want to.

Whichever option you choose, do the research to see which one is better for your situation. If you qualify, either an FSA or HSA can help you better manage both short- and long-term health costs.

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