February 16, 2009


All of us are aware of the commonly discussed financial tools available to improve one's financial standing - saving/spending plan, Roth IRAs (and other tax-advantaged investment accounts), insurance, etc. Another very powerful financial tool available to most (yet unused by many) is a Flexible Spending Account. A Flexible Spending Account (FSA) is a program (available through one's employer) that offers tax advantages and allows employees to pay for [eligible] out-of-pocket health care and dependent care expenses with pre-tax dollars. Using pre-tax dollars provides an immediate benefit on those expenses that equals the taxes you would otherwise have paid on that money. In plain english -- a no-brainer!

Each year, employers provide an "open" period where you can elect to participate in an FSA (as well as make modifications to your other cafeteria plan benefits). If you miss this window, a "qualifying life event" is needed to avoid waiting until next year to enroll. Birth, adoption, and change in marital status are examples of common qualifying events.

The amount you choose to contribute on an annual basis is withdrawn from your paycheck in equal installments each pay period. Most employer plans offer two different flexible spending accounts - one for qualified medical/dental expenses, and one for dependent care expenses. You can opt to participate in one without participating in the other; you cannot, however, move unused money from one type of FSA to another.

It is important to give some thought to determining how much money you plan to contribute, because if you don't use the money you will lose it! For example, if you have $100/month contributed to the FSA ($1200 for the year) and have $1,000 of submitted [allowable] expenses, you will lose the unused $200. You do have a 2 1/2 month 'extension' (until March 15) at the end of the calendar year to submit claims toward the prior calendar year, not just a 12-month window.

FSA for Health Care Expenses.
The FSA to cover medical expenses not covered by insurance is the most commonly utilized plan. As you incur medical expenses not covered by your insurance, you submit an invoice* with proof of payment to the plan administrator who will then issue payment. Any medical expense the IRS considers deductible (that is not reimbursed through your insurance) can be reimbursed through the FSA. Examples include co-pays, deductibles, braces, prescriptions, lasic surgery ... IRS Publication 502 provides an exhaustive list of allowable (and non allowable) medical and dental expenses. Your employer may edit this broad list, so make sure you check in advance to ensure your desired expenses will be covered. Unlike dependent care FSAs, there is no IRS cap on medical FSA contribution limits. The annual cap will vary by employer.

FSA for Dependent Care Expenses.
The dependent care FSA is federally capped at $5,000 per year. While married spouses can each elect to have this amount deducted from their paycheck and applied to expenses, at tax time all withdrawals in excess of $5,000 are taxed. While medical FSAs almost always favor the taxpayer, dependent care FSAs can be more complicated. They involve examining trade offs between pre-tax deductions and tax credits. Enhancements to child tax credits in recent years have made them more attractive than dependent care FSAs for many taxpayers.

*Many employer FSAs now provide debit cards which allow for an electronic transfer of pre-tax dollars from an employee account when paying for qualified expenses. Employees can use their medical and dependent care funds by using their card at the point of service. The traditional paper process is eliminated, as are worries of lost receipts or expenses you'd otherwise forget. A nice improvement.

- FSA Facts
- Health Savings Accounts & Medical Savings Accounts
- IRS Publication 969 (Tax-Favored Health Plans)
- Review this calculator to estimate your potential annual tax savings.