- Jerry Ripperger, director of consumer health for the Principal Financial Group, Des Moines, Iowa.
Last week, we looked at the connection between health and wealth. Indeed, health is the true wealth, for without the ability to do the things you enjoy with the people you love, wealth is of little use.
This week and next, we’ll examine two under-utilized financial instruments that can help with both health and wealth: FSAs (Flexible Spending Accounts) and, in next week’s post, HSAs (Health Savings Accounts.) These accounts help savvy participants save many hundreds of dollars each year by making many healthcare expenses fully tax deductible. Benefiting employees and employers alike, FSAs provide a way for both to combat the rising cost of healthcare.
Understanding Flexible Spending Accounts
You may have heard of FSAs. But what are they, exactly? Who can use them? What are the pros and cons? And most importantly, how can you save money with them? Let’s take a look at how you can maximize savings using an FSA with a minimum of risk or frustration.
FSAs in a nutshell: A health care Flexible Spending Account (FSA), also called a Flexible Spending Arrangement, is an employee benefit offered by most large employers and, increasingly, small businesses as well. FSAs allow employees to put aside before-tax money from their paycheck to pay health-related expenses that aren’t covered by insurance.
How it works: The money taken out of your paycheck is put aside in an account that your employer (or a subcontractor hired by your employer) oversees. You might be issued a debit card (called a FlexCard) to pay for healthcare expenses directly, or your company might require you to submit receipts for each reimbursement.
The big advantage: By contributing to an FSA to cover expenses you would have paid for anyway, you reduce your gross taxable income by that amount, which in turn lowers your tax bill. For employees in a 25% tax bracket, it means that every dollar funneled through an FSA to pay for healthcare related expenses can bring a quick return of 31% or more! (Last we checked, savings accounts and money market funds weren’t earning quite that much.)
An example: If you earn $50,000 a year and are in the 25 % marginal tax rate, every $100 you put in your health care FSA means that your $25 stays in your pocket instead of going to Uncle Sam. The higher your tax bracket, the more you’ll save. Plus, you’ll save additional dollars on Social Security taxes, Medicare taxes, and state income taxes, if applicable. You can wait for a tax-time refund, or better yet, adjust your withholdings and collect your savings now in the form of increased take-home pay.
Another way to look at an FSA is that it effectively allows you to buy health-care services at a significant discount using pretax dollars. Even employees who rarely get sick can save significantly on lasik surgery or dental work. Simply put, using an FSA makes healthcare more affordable.
The catch? The FSA funds are “use it or lose it” within each calendar year. The money diverted from taxable income must be used on allowable healthcare expenses within the time frame. Some companies are now voluntarily taking advantage of a two-and-a-half “grace period,” but even so, you’ve got a time limit to use the monies put aside.
It’s not hard, though, to find expenses that qualify. FSA funds can be used for:
- Insurance co-pays and deductibles. (Premiums are not deductible.)
- Vision expenses, from contact solution to prescription sunglasses.
- Dental care (except for cosmetic procedures such as whitening).
- Prescribed medication, painkillers, immunizations, and over-the-counter medication, when purchased with a doctor’s instructions.
- Equipment for diabetes testing and care.
- Multi-vitamins and prescribed supplements.
- Blood pressure and heart rate monitors.
- Equipment such as crutches, braces, wheelchairs, orthotics, hearing aids, even retrofitting a home to accommodate a disability or injury.
- “Medically necessary” trips to the acupuncturist, chiropractor, even the hypnotist and massage therapist.
- Transportation to and from doctor’s visits, including mileage and parking.
- Most smoking cessation, drug and alcohol recovery, and weight-loss programs. (You can even use your FSA to pay your gym membership with a doctor’s note.)
- Everything you need for home health care, such as first-aid kits, sunscreen, cold and allergy remedies, pregnancy tests, bandages, thermometers, shoe inserts and alka-seltzer!
Use your FSA – or Lose the Savings!
Do FSAs work? Absolutely! Employees who use FSAs contribute an average of just under $1500 to their FSAs and typically save between $250 and $640 each year in taxes. Even greater savings are enjoyed by those in higher tax brackets, who also tend to put the most into their FSA’s. But the irony is this: Most employees don’t use FSAs, saving nothing at all!
According to consultancy Hewitt Associates, over 94% of large employers offer such accounts. And yet, their April 2010 analysis of more than 220 employers revealed that only about 20% of employees utilize FSA accounts. Another study showed only 22% of eligible employees use FSAs. They miss out on the savings because they don’t want the hassle, don’t understand the benefits, or fear the “use it or lose it” provision.
Simply put, benefits of FSAs are compelling enough that any eligible employee (and business owner) should be strategizing how to best use it. Other perks:
- FSAs can eliminate the need to itemize medical expenses. (You can declare expenses on your tax form or use your FSA, never both.) And unlike itemizing, you start saving at dollar one, not after you’ve hit $7,500 of itemized expenses.
- Funds can be withdrawn to pay qualified medical expenses even if you have not yet placed the funds in the account. If you have more medical expenses early in the year, your contributions catch up later.
- Unlike a Health Savings Account, FSAs may be offered and used even if employees are not covered by health insurance or any other health care plan.
- Taxes saved now do not translate into potentially higher taxes down the road when funds are withdrawn, as with qualified plans.
- FSAs enforce consistent saving for health care expenses. They help people budget.
As good as FSAs are, they are not without hitches. In 2013, new limitations curb the savings for those who have utilized them for maximum savings. Prior to 2013, employers could set their own maximums, often from $3,000 to $5,000. Now, health care FSA’s are limited to $2,500, with cost of living increases to come. (However, the other FSA – Dependent Care FSAs, which can be used for daycare and more, remain capped at the higher $5,000 limit.)
Another issue with FSAs is that not everybody gets one! If you are self-employed, provide your own insurance, or work for an employer that doesn’t offer FSA’s, then you won’t be able to take advantage of the benefits. (However, see our next post about HSAs or Health Savings Accounts.)
But the greatest disadvantage remains the “use it or lose it” rule. Trying not to over-fund their FSAs, some employees underfund them. Yet even without a crystal ball, they remain beneficial. For instance, if an employee puts $1,000 into their FSA and only uses $850 or $900, they still come out ahead. (Incidentally, unused funds are forfeited and can be used by employer towards administrative costs of the plan, or contributed back to the plan as a dividend or “premium offset.”)
How to use your Flexible Spending Account effectively:
1. Sign up! If your company offers an FSA, the first step is to find out when the enrollment period is and to participate. If you are a small business owner, consider setting up an FSA program if you don’t already offer one.
2. Evaluate your expenses. Employees tend to over-estimate their first year. Monitor your current expenses and examine past healthcare spending before determining a deposit amount, rather than simply guessing. Be aware of what is already covered under your health insurance plan, too.
3. Pay Attention. You may be used to picking up sunscreen, vitamins and cough syrup with the groceries, so be sure you’re making purchases in the correct way, using the FSA debit card and/or saving receipts.
4. Get it in writing. Ask your doctor to write prescriptions for over the counter (OTC) medications and referrals such as chiropractic care, acupuncture, or therapeutic massage.
5. Watch the calendar! Do you have leftover funds as you near the end of the year?Stock up on your first aid supplies, vitamins, eye care products, and other consumables. There’s even an online FSA store dedicated to nothing but qualified products and supplies. December is also a great time to pick up prescription eye wear.
6. Donate! Leftover funds cannot be donated, but consider purchasing items such as a First Aid Kit, sunscreen, or equipment to donate to a local Boy Scout troop, camp, clinic, or neighbor in need. Flex Aid helps match employees with extra end-of-the-year FSA funds and clinics in need of supplies
Are you looking for a holistic approach to wealth? At Partners for Prosperity, Inc., we look at your whole personal economy, not simply your portfolio of investments. We’ll help you find ways to spend less on taxes and debt so you can build sustainable wealth that you don’t have to wait to “retire” to enjoy. For an overview of our approach, which we call “Prosperity Economics,” we invite you to read Busting the Financial Planning Lies, available as an ebook, audio book, or paperback.