FSA Planning

If you are lucky enough to have a job that provides you with the option of a Flexible Spending Account (FSA), you probably received a notice from the administrators of that account telling you that your open-enrollment period is here (or fast approaching). Why should you consider taking advantage of this benefit?  And how do the new health care reforms affect your plan?

FSA programs allow account holders to set-aside pre-tax money to pay for medical expenses for themselves and/or for their dependents. In this post, I’ll be focusing on the benefits for accountholders rather than for dependents (I do not have children, and FSA benefits do not cover veterinary expenses). In short, account holders can use these funds to pay for out-of-pocket expenses such as co-pays, prescription drugs, medical treatments, prescription eyeglasses, dental visits, and other approved expenses. Basically, an FSA allows you to reduce your taxable income and increase your take-home pay. The minimum and maximum amounts that you can contribute to your account are determined by your employer, but the maximum contribution allowed by the IRS is a $5000 per person per year.

There are three three things you need to be aware of when considering an FSA account:

1. The first is the use-it-or-lose-it factor. This means that users must decide during the open enrollment period (for most of us, this is right now) how much to contribute for the entire upcoming calendar year. Those funds are then deducted from each paycheck over the course of the year (though the entire amount for the year is available as of January 1). There is a grace period in January that allows people to spend leftover money, but whatever funds they do not spend by the end of that period will be forfeited.

   Here’s an important change to FSA’s for 2011. Until the end of 2010, FSA account holders can also use these dollars for over-the-counter remedies such as allergy medications, antacids, or cough syrup. As of January 1, 2011, account holders will need a prescription from their doctor to use FSA monies for any over-the-counter medicines. This means that predicting how much money one should set aside just got more difficult. It was almost painless in the past because if an FSA holder had money left, she could just buy a supply of the family’s frequently used OTC medicines. In other words, in previous years, one could stock up on allergy medicine, cough drops, and ibuprofen as a way of spending that leftover money. That fallback won’t be possible next year without a prescription. The sole exception to this rule is insulin. The good news is that FSA monies can still be spent on approved items that are not drugs or medicines. So you can still purchase extra bandages, reading glasses, contact lens supplies, and similar approved products with your unspent FSA dollars.

2. The second FSA factor be be aware of is the fact that account holders cannot alter their selections until the next enrollment period unless they participate in what is called “a qualifying event,” for example: marriage, divorce, or the birth of a child.
3. The third and final factor is (in)convenience. In addition to the yearly planning, in most cases using an FSA adds at least one step to applicable purchases. Some employers issue a debit card to FSA holders so that they can pay their expenses at the point-of-sale be it a drugstore or doctor’s office. Alternately, users can pay by other means and submit receipts via fax or the postal service for reimbursement. Note that even if you elect to use the debit card, you may still be required to submit receipts to verify your purchases.

As mentioned above, using FSA benefits is about to get a bit more complicated, but most financial advisors agree that the savings are worth the extra hassle for many Americans. If, for example, you know for sure that your family will have $1000 worth of qualified expenses once you add up your doctor’s office visits, your prescriptions, and your dental work (or a year’s supply of contact lenses), if you are in the 34% tax bracket, you are looking at a savings of $340 over the year. Even if you only have $500 worth of expenses, you would still save $170.

How do you calculate how much money you should contribute to an FSA account? It’s pretty simple. You can visit this website for an FSA expense calculator. Tracking monthly medical bills and expenses is really easy if you use a financial tracking program like Mint. Even if you don’t use Mint but do use a credit card, you can review monthly statements online to see how much you typically spend a month. If your expenses are consistent each month, then multiple the average month’s expenses by 12, and you are finished. If your expenses are not consistent, then you might want to track spending for the average costs over a 3, 4, or even 6 month period instead of for a single month. Just remember, it is better to underestimate than to overestimate. You can only stock so many band-aids before you run out of space in the medicine cabinet.

Do you use an FSA?  Do you have suggestions or tips for our readers?  Please share them in the comments section below.

[Creative Commons licensed image by Flickr user diekatrin.]