I’ve gone in to great detail on health savings accounts (HSA’s), but have paid little attention to their cousin, the flexible spending account, aka an FSA (oddly, the IRS refers to them as “flexible spending arrangements“, but I have never heard anyone else us that term).
HSA’s are tax advantaged savings accounts that can be used to pay for eligible medical expenses. They are paired with high deductible health plans (HDHP’s). Tax-free (pre-tax) contributions and withdrawals for qualified medical expenses, employer contributions, and growth through investments make them an outstanding option for those who are eligible.
And that’s the rub.
In order to be eligible to contribute to an HSA, you must be currently enrolled in an HDHP.
What if you are not enrolled in an HDHP? Then you should give some strong consideration to contributing to a FSA instead.
So I thought I’d give a little Q&A format rundown of flexible spending accounts – their pros, cons, maximum contributions, eligible expenses, & just about anything else I figure people might be curious on. Open enrollment for health care and other employee benefits are is coming up shortly, so now is the time to figure out if a FSA is a good fit for you (and how much you should contribute).
What is an FSA?
The main purpose and benefit of contributing and using a FSA is that any contributions made are pre-tax dollars. However, any qualified medical expenses paid for using the FSA are tax-free dollars. So you effectively pay no taxes on those expenses, by virtue of reducing your taxable income.
If you are in the 33% tax bracket, for example, any qualified expenses paid for by an FSA, would essentially result in a 33% out-of-pocket savings.
All contributions to an FSA are voluntary.
What are FSA Qualified Medical Expenses?
Expenses that are eligible to be paid for by HSA’s are also eligible to be paid for by FSA’s.
Common eligible expenses include dentist and doctor visits, procedures, and co-pays, prescription drug costs or co-pays, laser eye surgery, eye exams, contacts, eyeglasses, and chiropractor visits.
If you have any medical conditions that require special equipment or treatment, these expenses are typically covered as well.
For a full list of what medical expenses are covered by a flexible spending account, check out IRS publication 502.
Five medical expenses that are not covered by FSA’s, that one might commonly believe are:
- Amounts paid for health insurance premiums.
- Amounts paid for long-term care coverage or expenses.
- You can’t pay off outstanding bills incurred prior to your plan year.
- Domestic partner and children of domestic partners are not eligible to participate in the healthcare FSA.
- Over-the-counter (OTC) drugs.
When you can Contribute to an FSA?
You must elect your FSA contributions at the beginning of the plan year. Then, your employer will deduct amounts periodically (generally, every payday), pro-rated to align to your annual election. You can change or revoke your election only if there is a change in your employment or family status that is specified by the plan.
What is the FSA Maximum Contribution?
The IRS set a maximum FSA contribution limit in 2018 at $2,650 per qualified FSA (previously, there was no set maximum limit). As with other tax advantaged accounts, the maximum contribution is annually indexed to inflation.
Oddly, many employers might only offer that you can contribute at levels below the IRS maximum. This is unlike the 401K maximum contribution, where all employees can contribute up to the federal annual maximum.
And there are some ways to get around the maximum.
If you hold two or more jobs (with unrelated employers), you can elect up to $2,650 (2018) under each employer’s FSA plan (or up to each employer’s maximum allowed). If married, each of two spouses can contribute to their employer’s plan (effectively doubling the total contribution).
What are the Key Difference Between an FSA and HSA?
If you’ve had an FSA in the past or are considering one, you are probably wondering how FSA’s differ from HSA’s. There are a few key difference when comparing HSA’s vs. FSA’s:
- You own an HSA, your employer owns the FSA. In other words, you can take an HSA with you if you leave your employer, but you cannot do the same with an FSA.
- You can roll over HSA funds from one year to the next, you cannot do this with an FSA.
- You can invest funds in an HSA, you cannot with an FSA.
- Contributions maximums between the two differ.
Which is better? HSA features and benefits are superior to FSA’s. However, FSA’s are a solid benefit for those who are not eligible to contribute to an HSA.
The FSA Use-it-or-Lose-it Rule
The biggest downside to FSA’s is the so-called “Use it or Lose it” rule, as dictated by the IRS.
This rule says that you must use all of your annual contributions to a FSA by the end of that calendar year.
The challenge is you need to make your annual election before the start of the plan year. And if you overestimate your expenses, you lose your contributions.
The IRS is re-evaluating the FSA “Use it or Lose it” rule, because many people are afraid of it (for good reason) and end up not contributing at all.
Update: the IRS is now allowing employers to implement a $500 carryover rule at their discretion.
However, you should not let the rule scare you off from contributing altogether – as that would be your loss.
How Much Should you Contribute to an FSA?
This is the tricky part. You have to elect how much to contribute to a FSA before the calendar year begins. And you lose what you don’t spend.
So how much should you contribute to an FSA, so you cover most of your expenses without losing them at the end of the year.
This will take a bit of predictive analysis.
The most common uncovered and qualified medical expenses you might have typically include:
- dental co-pays
- prescription drug co-pays
- prescription eyeglasses and/or contact lens
- eye exams or eye exam co-pays
- orthodontics
Use your estimated expenses in these areas as a base-line. Beyond that, add in any other predicted expenses for your family. If you have special medical needs that you are 100% sure you will have that exceed the maximum annual contribution your employer allows, then it makes a lot of sense to max out your FSA for that year.
Flexible Spending Account Discussion:
- What questions do you have about FSA’s?
- Do you contribute to an FSA?
- How much do you contribute annually, and how do you calculate that amount?
- Have you ever been burned by the “Use it or Lose it” rule? How much did you lose?
Related Posts:
My employer has an FSA that can be used for daycare. We missed open enrollment last year (didn’t realize they offered it until later), but we are definitely enrolling this year. Daycare is expensive, and paying for it with tax-free money is going to be sweet…
I believe that is referred to as a ‘dependent care FSA’ – and is specific to those who claim dependents. It has slightly different rules than a standard FSA.
Here is more info: http://www.irs.gov/pub/irs-pdf/p503.pdf
HSA’s sound great…until you realize they are tied to HDHP’s.
Not that I’m unhealthy (no regular medications or issues) but in recent years I’ve had a shoulder injury that cost me out of pocket $1000 when I was on a PPO plus monthly deductible in the range of $50 that would have cost me $40 with an HMO plus $90 (currenlty, then it was not available but comparing now it would have been $65)…So $1600 vs today’s $1120. Sure HSA is tax free but who plans for a shoulder injury that is going to cost this?
Or, in 2011 I was diagnosed with bilateral hernia’s that I had taken care of. Total bill from hospital was $17,000. I had a couple doctor’s appointments for sanity’s sake and pain killers after the procedure so $100 (rounding up) and $1080 a year in premiums vs $3000+ out of pocket with a PP0 PLUS monthly payments of another $75 means that the surgery would have been $3900 plus. I’ve never had a PPO bill come out to what the ‘plan’ shows it should be so I’m sure it would have been over $4000.
So just in my last 5.5 years an HMO would have saved me $4860 not including premiums. Difference per year in premiums is $180, so really it is $3870.
That is nothing to sneeze and due to the savings I have incured with an HMO (using an HSA), I would never consider an HDHP with an HSA anytime soon. If I were to switch, I know the difference in monthly cost would go straight to an HSA and I could see that money grow until I get nailed with somesort of expensive issue. $180 at 5% a year is $9. That’s going to take a 16 years but I’ve spent that much in 5.5….
Don’t forget that pre tax elections also help avoid the payment of FICA taxes. Employees pay 7.65% and employers match that amount.
That takes your example of savings to 40% of income. Keep that savings in mind when concerned about the use it of lose it rule. You would have to lose more than 40% of your contribution for an FSA not to pay off. As long as you are contributing predictable expenses you should be OK>
G.E. – Thanks for the timely post.
I currently have a HSA but will be switching to a FSA during enrollment next month. Although my company contributes half of the HDHP deductible amount to my HSA account, I miscalculated the true cost of my medical expenses (e.g., prescriptions) and will probably end up paying more than if I had a standard PPO. Equally important, I plan on getting Lasik done in January. Utilizing an FSA will essentially give me a massive 20-25% discount using pre-tax dollars, and the PPO will allow me to pay normal co-pays for other prescriptions.
I plan on calculating my contribution amount (which, for my plan, is available IN FULL on the first day of the calendar year) by taking the cost of Lasik, subtracting medical plan discounts (5%), and dividing the total by 24 pay periods. I may also utilize my leftover HSA balance or save it for future miscellaneous medical expenses. Since this procedure will earmark most or all of the $2,500 IRS FSA contribution limit, I may keep the FSA the following year if I plan on getting another expensive procedure done (e.g., orthodontics/invisaline). Like you have said all along, the ideal type of coverage is unique to a person’s health and anticipated and planned medical costs, but the risk of both is that not all medical expenses can be planned.