Flexible Spending Accounts (Part 1)
Posted on: October 21, 2014Categories: HR & ComplianceWhat Are Health FSAs?
An FSA is an employer-sponsored savings account for health care expenses. You are not taxed on the money put into the FSA, and you can then use the account to pay for qualified out-of-pocket health care costs, such as your deductible and copays, but not your premium. However, you cannot stockpile money in the account from year to year, and you will lose leftover money in the account at the end of the plan year unless your employer offers an option that allows for either a short extension or a small carry-over into the next year.
FSAs were created in the 1970s to enable employees to use pre-tax dollars for health care expenses that were not otherwise covered by employer-sponsored health coverage. These accounts gained more popularity in the 2000s, and they underwent a few changes with the Affordable Care Act (ACA), including the addition of an annual contribution limit.
Health FSAs can save you money on taxes while helping you regularly put aside money for health care expenses. If carefully planned, using an FSA for health care costs can be an asset to your family’s budget.
Why Have a Health FSA?
Health FSAs offer an option for setting aside money to use for qualified medical expenses. These accounts offer a convenient way to prepare for out-of-pocket medical expenses while saving on taxes. In addition, you can use your health FSA to pay not only for your medical expenses, but also for the medical expenses of your spouse and dependents.
Health FSA Advantages
Here are some of the advantages an FSA can provide:
Tax reductions: The amount you contribute to a health FSA is not subject to federal income tax or social security (FICA) tax—effectively adjusting your annual taxable salary. The taxes you pay each paycheck and collectively each plan year can be reduced significantly.
- Your employer can also contribute to your FSA, and this amount is also not considered taxable income to you.
- You can withdraw money from your FSA to pay for qualified medical expenses (see Appendix) and your withdrawals are not taxed.
- You do not have to report FSA amounts on your income tax return.
Convenience: After the initial election at the beginning of the year, your employer will take care of transferring the allotted amount into your FSA through salary deferral.
Flexibility: You can withdraw health FSA funds at any time (for qualified medical expenses), even if the amount has not yet been deposited into the account, as long as the amount is no more than your elected annual deferral amount less any amount already used.
Is a Health FSA Right for You?
FSAs can save you money because you don’t have to pay taxes on the amount deferred to the account. However, using an FSA does require careful planning in order to reap the financial benefits.
When you participate in an FSA, you have to decide at the beginning of the plan year how much to contribute for the year. Because you will generally lose what you don’t use by the end of the year, determining how much to defer into an FSA can be challenging. While correctly estimating your health care expenses and using an FSA to pay for those expenses will save you money, incorrectly gauging your health costs could cause you to lose money.
How your employer manages the FSA may also affect how much you will benefit from using an FSA. If the employer provides a grace period or carry-over option (see “Grace periods and carry-overs” section), you will have a little more flexibility when using your FSA funds. The largest downside to using an FSA is that if you over fund your FSA and don’t use the amount in there, you will lose what you’ve saved.
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