Flexible spending accounts were introduced in the 1980s. Money is set aside in a designated account through payroll deductions; you pay no income or social security taxes on this money. When you incur medical expenses not covered by insurance, you are reimbursed from your account.
According to the Mercer/Foster Higgins National Survey of Employer-Sponsored Health Plans, last year, the 19 percent of employees who had a flexible spending account put an average of $1,023 into them. With FSAs, the higher your tax bracket, the more money you save through these accounts. Assuming the average employee is in the 35 percent bracket and designated the above amount to an account, he or she saved $358 last year.
If you haven't spent all of the money you set aside by year's end, you lose it. That may be one reason more people don't choose to participate. Others think, mistakenly, that if they have good health insurance the accounts are not necessary. However, you can pay for a surprising number of things out of this account that aren't covered even by a great insurance policy. For example, the average healthy couple could easily spend the following each year:
- Co-pay on 2 general doctor visits: $30
- Co-pay on 4 dentist visits: $60
- Co-pay on 1 eye doctor visit: $15
- Contact lenses: $70
- Allergy medication: $120
- Contraceptives: $400
In this example, the expenses total $695. Martin says the tax savings will total $211.96.
"If you will have $300 or more in out-of-pocket health care costs next year, running that amount through these accounts will save you $100 in taxes," Martin said. "The total time to set up, send in receipts and deposit the reimbursements is less than one hour. Is your time worth $100 an hour?!"
According to the IRS, the money can be spent on anything that's a genuine medical need. Of course, this includes all of the common health expenses, such as those in the above example. However, Martin says some of the included expenses are a little more surprising.
- Car expenses such as gas and oil when using your car to drive to a medical appointment
- Inpatient treatment for alcohol addiction
- Buying or renting crutches
- Insurance premiums for policies covering medical care
- Removing lead-based paint from your home
- Travel and lodging costs incurred when visiting a medical facility away from home
- Travel and admission to a medical conference that concerns a chronic illness you have
- Sterilization or abortion
- Weight-loss programs (such as Weight Watchers, NOT a gym membership)
- Wigs (if illness caused you to lose your hair)
- Massage (if a doctor says it will help you)
Martin says there is a second type of flexible spending account that allows you to set aside money for child and dependent care. Among other things, the money can be used for: school tuition or special tutoring for a child with a severe learning disability, nursing home costs, costs of a special home for the mentally retarded, day care for seniors and children under 13 - including day camps or after school programs.
These dependent care accounts work just like the medical flexible spending accounts. The only difference: there is an annual contribution limit of $5,000. Companies can set their own limits for the medical accounts.
For both types of flexible spending accounts it's important to carefully consider the amount of money you plan to set aside. The fear of losing money in these accounts keeps many people from using them. But it's not difficult to estimate out-of-pocket costs for the year.
Tally last year's expenses: This is a good guide to what you'll spend in the upcoming year. Look for changing costs: Health care premiums are rising an average of 12 to 18 percent in 2003.
Health care companies are sure to pass some of these costs along to consumers by raising the cost of deductibles, drugs and office visit co-pays.
Martin recommends planning for one-time expenditures: Want to have that laser eye surgery? Your child needs braces? These are things that you can plan for and thus budget for. Add these anticipated costs into your spending account.
Finally, don't panic if you have a flexible spending account and have not spent all of your money yet this year. It's not too late to buy new glasses, get that physical you've been putting off or stockpile prescription drugs you use on a regular basis. Some treatments that take place over several visits, such as braces, may allow you to pre-pay, thus using the rest of your account money, receiving a receipt dated 2002, and then completing treatments next year.