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How Does A Flexible Spending Account (FSA) Work?

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This year my company informed us that our company's health care costs were starting to get out of control.  Premiums for employees and for the company's portion of the bill were rising.  With all the uncertainty that has come with Obama's Health Care plan and as to what will be covered in the future, this year the company decided to kick the can down the road on making hard decisions with the company's health care plan and do a few things to help us save money this year.  One thing that they implemented for employees this year was a flexible spending account or FSA.  By using this FSA our family will save hundreds of dollars this year on our taxes.

While the FSA has worked out great for us because of our high health care spending at our household this year (we had a baby), it may not be the right option for everyone.  We'll explain below.

So What Is A Flexible Spending Account (FSA)?

Flexible Spending Accounts aren't something you're going to find at all places of employment because not everyone offers them.  In addition if you're self employed, you aren't able to participate in a FSA plan.

Usually how the FSA plan will work is your company will have an open enrollment period where you can sign up for the company's plan.   Our company had that enrollment period earlier this year when we jumped on the opportunity because we knew we were going to have a lot of medical expenses this year with a baby on the way.

When you sign up for your company's plan you'll need to elect an amount that you want deducted pre-tax from your paycheck.  That amount you elect to have deducted from your pay will then be split up into your pay periods and deducted from each check.  By deducting the money pre-tax it means that you're saving a good amount of money on taxes for the year.   The more you deduct for your expected medical expenses, the more you'll save.

Normally you can’t change your amount you’ve elected to deduct from your pay during the year unless certain life events have happened and there has been a change in your employment or family status. (you have a baby or get a new job)

FSA Contributions

As mentioned above when signing up for your FSA you'll need to tell your employer how much you want to contribute to your account for that year.  To do that you'll want to estimate how much money you think you'll be paying  on medical expenses for the year out of pocket for things like doctor's visits, prescriptions, dental care, and so on.

The government doesn't currently have a limit for the amount that you can add to your FSA account, although most employers will cap the FSA account at a certain percentage or around $5000.  My company plan has a limit of $5000, although we designated less than that at $3000 for the year.   With that amount we were reasonably sure that we would be able to spend all the money as we were having a baby this year.  Remember, you need to be careful about how much you designate for your account, because you have to spend the money – or risk losing it! More on that in the next section.

Our plan has a maximum of $5000 that you can contribute, and at this time we’re contributing $3000.  We are expecting our first child this year, and we expect to have substantial medical bills because of that, so using a FSA this year is a good choice for us.  With the life change event in July when the baby is born we can elect to increase our contributions if needed.  If we expect to use all $5000 of the maximum allowed, we can add the extra contributions to our plan at that time.

FSA Contributions – Use It Or Lose It

FSA plans in most cases have a rule that you must spend the funds added to your account during the year, or you'll lose the money to the plan where it will be used to help cover costs of other plan users who have left their job during the year (before they could add all their funds to the account – even though they've used up their total amount already).

Since funds are subject to forefeit you'll want to make extra sure that you are careful about estimating your health care costs and that you come as close as possible to the reality of what your costs are.   For us, we knew just about what we would spend this year based on our spending last year, and the estimated costs of having a baby at our local hospital. In the end we'll end up spending a bit more than we have in our account, but I would rather under-estimate than over estimate – and lose the funds.

FSA Funds Can Be Used At Any Time – The FSA Loophole

One thing that is nice about adding money to a FSA is that you can use your elected funds at any time after you sign up. For example, we have only put in about $1000 in our account so far this year, but within the next couple of weeks we'll have submitted for reimbursements from our account for the full $3000 amount.  As long as you've signed up for the account, and are in the plan, you can use up to your full plan election amount at any time.

This point of the FSA has been referred to as the FSA loophole because if you end up leaving a job only part of the way into the year, you no longer have to make contributions to your FSA, even though you’ve used all of your money for the year.  The negative balance in your account is balanced out by funds not used by other plan members who have forfeited their funds at the end of the year.

You will sometimes see people who are planning on leaving their company sign up for the FSA plan anyway, knowing they can take advantage of the loophole.

Getting Reimbursed For FSA Approved Expenses

For most FSA plans how it works is you'll pay for all of your health care expenses out of your own pocket, and then once you pay you just submit a claim for reimbursement.   Usually you'll get reimbursed in one of three ways.

  • By Check: You submit documentation of your approved expenses, and within a couple of weeks you'll receive a check in the mail.  If something isn't approved or you need further documentation, you'll receive notice.
  • Direct Deposit:  Again, submit your documentation proving your expenses, and if they're approved you'll have the money deposited directly into your account. For us, this is the way our plan works – we submit a fax to the Flex Spending plan administrator and they approve our expenses or ask for more documentation.
  • FSA debit card: Some plans will just give you a debit card for your flex spending account that allows you to use it to buy approved expenses directly using your funds.

Changes To Flex Spending Accounts Due To Obama Care

After the health care law was passed earlier this year there were a couple of pretty big changes made (for the worse in my opinion).

  • Over the counter medicines: Starting next year in 2011, flexible spending account money cannot be used for over-the-counter meds unless they are specifically prescribed by a doctor.   In current law your FSA funds can be used for over the counter drugs and other items such as eyeglasses, contact solution, bandages and non-prescription forms of birth control.
  • Limits on your contributions: Starting in 2013, your contributions to  your FSA will be capped at $2,500 each year with annual inflation increases. Although there are currently no limits, most employers cap the maximum somewhere around $5,000.

Why are these changes being made?  Because they want to collect as much tax money as possible in order to help pay for the trillion dollar Health Care plan.  Personally I'm not happy about it as it means I'll most likely end up having to pay for more taxes.

Why FSAs Are Great

If you know that your family will be incurring substantial medical costs during the year, using a FSA plan sponsored by your employer is a great idea.  If you estimate how much you'll spend, or even if you know that you'll be leaving your job and want to take advantage of the FSA loophole, you can come out substantially ahead.  At our house this year we estimated the amount we were going to spend at around $3000, and in the end we'll end up saving almost $1000 in taxes.   Want to figure out how much you could save, check out this FSA Savings calculator.

Do you have a flexible spending account?  How much were you able to save in taxes due to your FSA? Tell us your FSA experience, or ask us questions in the comments!

Personal Finance Basics: The Power Of Compound Interest

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We've all probably heard that we need to think about retirement, even from a young age.

We're told that we need to get a retirement account, and start saving – the earlier the better!

Have you ever wondered why you're better off if you start saving for your future earlier? It's the wonders of compound interest!

Compound interest is the eighth wonder of the world.  He who understands it, earns it.. he who doesn't.. pays it. 


– Albert Einstein

What Is Compound Interest?

Everyone knows that earning interest on your money is a great thing – but what are the different kinds of interest you can earn?

  • Simple interest: Simple interest charges interest only based on principle value;   Let's say you lend $1000 to someone you know.  If  you lend it to them on a 5% rate per year on simple interest – that friend would owe you $50 each year  before they pay you back.
  • Compound interest: Compounding interest charges interest on the principle value as well as the value of any interest previously accrued. So in the same example, if you charged your friend a 5% yearly compounding rate,  he'd owe you $50 the first year, then 5% of $1050 the second year – $52.50 –  (if no payments were made), and so on.   The end result is that your friend would owe you increasingly more under compounding interest the longer it took for him to pay you back.

Here is the formula for calculating compound interest – from Wikipedia:

Where,

  • P = principal amount (initial investment)
  • r = annual nominal interest rate (as a decimal)
  • n = number of times the interest is compounded per year
  • t = number of years
  • A = amount after time t

So here's an example:

An amount of $1500.00 is deposited in a bank paying an annual interest rate of 4.3%, compounded quarterly. Find the balance after 6 years.

A. Using the formula above, with P = 1500, r = 4.3/100 = 0.043, n = 4, and t = 6:

So, the balance after 6 years is approximately $1,938.op.

Why Is Compound Interest So Great?

The reason why compound interest is so great is because not only do you earn interest on your principal balance, or the money you started with – but you also earn interest on your interest!    If you are looking to grow wealth over a long period of time, compounding will definitely work in your favor and help you to achieve some exponential gains.

In fact, if you have a long enough time horizon and depending upon the interest rate,  the money earned off of the interest alone can be greater than the principal invested at the start!  See this chart for details:

Chart via thetaoofmakingmoney

Remember, however, that compound interest can work against you as well, so make sure that you're the one holding the reins, and like Einstein said, that you're earning it and not paying it.

What do you think about compound interest? Are you earning it or paying it?  Tell us your thoughts in the comments!

Want to find out more about compound interest?  Check out this great post and infographic about compound interest:  Compound Interest Infographic.

When You Make Financial Mistakes, Don’t Allow It To Snowball

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I was thinking earlier this week about why sometimes people will find themselves in dire financial straights – situations where they can't seem to get out, even when they seem to have the resources or the smarts to be able to.  After thinking about it, I realized that a lot of the problems we get ourselves into, and the reasons why we can't get out of them, are really just psychological battles.  We allow ourselves to believe negative things about ourselves or our situations that keep us in trouble.  We end up not having the discipline to get ourselves out.

We All Make Mistakes

We all make financial mistakes in our lives.  Some of us make big ones.  We do things like buying expensive homes that we can't afford because we've fallen in love with the house – and we imagine ourselves living there.  Or we buy an expensive car because we can imagine ourselves living a glamorous lifestyle while driving that car.   Others make small mistakes like forgetting to pay a bill, or spending too much while on vacation.

It's fine to make mistakes – we all do it.  What sets the successful apart from those who can't seem to find their way out of debt is that they learn from their mistakes, and they move on.

Poor Decisions Can Lead To More Poor Decisions

Far too often I've seen friends who have made poor financial decisions take a mistake that they've made, and turn it into an even bigger mistake.  Instead of admitting they've made a mistake, they double down and continue the poor decision making.

I remember one friend in college who made some poor spending decisions, and found that he was going to be short on his rent payment that month.  If he had made a wise decision he probably could have admitted his mistake, and tried finding ways to make up his shortage.  He could have sold some of his video games, or got a quickie part time job to help make up the difference.

Instead, he allowed it to get him down, and he decided instead to go on a week long spring break trip – all paid for on his credit card.   Because he allowed his poor decision to get in his head and depress him, he tried to make himself feel better by spending even more money that he didn't have.    In the end he was only able to get out of trouble by begging his parents for a loan – which I'm pretty sure he never paid back.

Learn From Your Mistakes

Instead of allowing your mistakes to get the best of you, and before the snowball gets rolling down  that hill, nip it in the bud.  Don't let your mistake get in the way of your future.  Don't allow one mistake to beget another.

Instead, admit the gaffe, and do what you can to turn things around.   Make a plan for change and think about ways you can ensure that the problems don't arise  again.  Forgive yourself and move on.  Don't be destroyed by guilt, and don't allow your guilt to consume you to the degree that you give up.

If you bought a house you can't afford, cut your losses while you still can and sell the house.  If you've bought a car that is out of your price range, return it or sell it! And if the mistake can't be remedied – at least don't compound it by making new mistakes!

Have you ever made a financial mistake, and then compounded the problem by allowing it to consume you – and pushing you to do something else stupid? What are you thoughts on how problems can snowball out of control?

Obama Administration Offers $1.5 Billion In Foreclosure Funding For Hardest Hit States

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These past few years have been tough ones for homeowners, with home prices dropping, people finding that their homes are underwater, and foreclosure filings increasing all  the time.  In fact, there have been almost 2 million foreclosures so far this year!

RealtyTrac®  the leading online marketplace for foreclosure properties, today released its Midyear 2010 U.S. Foreclosure Market Report, which shows a total of 1,961,894 foreclosure filings — default notices, auction sale notices and bank repossessions  — were reported on 1,654,634 U.S. properties in the first six months of 2010, a 5 percent decrease in total properties from the previous six months but an 8 percent increase in total properties from the first six months of 2009

With the real estate and economic crises not having much of an end in site, this past month the Obama administration put together a $1.5 billion dollar fund to help the hardest hit states.

State Housing Finance Agencies (HFAs) in Arizona, California, Florida, Michigan, and Nevada  can begin to use $1.5 billion in “Hardest Hit Fund” foreclosure-prevention funding under plans approved today by the Obama Administration. This aid will support innovative local initiatives to assist struggling homeowners in those states, as part of the first round of funding available under this new program.

How The Hardest Hit Foreclosure Prevention Program Will Help

The programs for approved states will help homeowners in the following ways:

  • Assist struggling homeowners with negative equity through principal reduction.
  • Assist the unemployed or under-employed make their mortgage payments.
  • Facilitate the settlement of second liens.
  • Facilitate short sales and/or deeds-in-lieu of foreclosure.
  • Assist in the payment of arrearages.

State Specific Foreclosure Prevention Programs

Of the states that have been hardest hit by foreclosures-  and are a part of the program, here are details of how they will be helping.  From MakingHomeAffordable.gov

Arizona ($125.1 million)

  • Arizona will provide assistance in the form of principal reduction, interest rate reduction, and/or term extension programs with the goal of allowing borrowers to enter into a permanent modification program.
  • In circumstances where a second lien is prohibiting modification of a first lien, the state will provide assistance toward elimination of the second lien.
  • The state will also offer assistance to the under-employed while they seek new employment. This assistance may be used to pay monthly mortgage payments or remove second mortgages where that second lien is prohibiting the modification of a first lien.

California ($699.6 million)

  • California will provide assistance to reduce principal with earned principal forgiveness.
  • The state will also target funds to address delinquent loan arrearages.
  • California will offer a mortgage payment subsidy to unemployed families.
  • Provide funds to assist families that have executed a short sale or deed-in-lieu of foreclosure transition to a stable housing situation.

Florida ($418 million)

  • Florida will offer up mortgage payment assistance to the unemployed and under-employed while they seek re-employment. The state will also offer principal reduction or second lien extinguishment if necessary to achieve a mortgage modification.

Michigan ($154.5 million)

  • Michigan will subsidize an unemployed borrower's mortgage payments while they search for employment.
  • The state will assist with loan arrearages for those who can sustain homeownership and have undergone a financial hardship.
  • The state will assist homeowners with negative equity through earned principal forgiveness.

Nevada ($102.8 million)

  • Nevada will create a mortgage modification program using a combination of forgiveness and forbearance with a goal of reducing principal to less than 115 percent of LTV (loan-to-value) and lowering payments to 31 percent of DTI (debt-to-income).
  • The state will also offer assistance to reduce/eliminate second liens with earned forgiveness over a three-year term.
  • Additionally, the state will provide allowances for appraisal and transaction fees, moving fees, a legal allowance for up to three months, and a combination of incentives for borrowers and servicers to facilitate short sales.

More Funding For Foreclosure Programs A Good Idea?

There are a lot of people that need help, but the question is, are we just throwing good money after bad by continuing these foreclosure programs?  Are the programs really helping – or just prolonging the pain?

In reading up on much of the “Making Home Affordable” program, I read that of the people that got help, a high percentage of them still had problems and went into foreclosure anyway.  So the question is, if we aren't really helping people anyway, just prolonging the pain – why do we keep kicking the can down the road?

What do you think? Should we continue providing foreclosure prevention assistance to homeowners? Are we just prolonging the pain -or is this and other programs actually going to help?  Tell us your thoughts in the comments.

Three Steps You Can Take To Turn Your Financial Life Around

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After we got married just over 8 years ago, my wife and I entered the marriage with more debt than we would have liked.  My wife had zero debt, and I came in with student loans, credit card debt (for our honeymoon) and a loan for my car.   We weren't happy with having so much debt, and after a couple of years of slowly paying off the obligations, we decided to take things a bit more seriously.   We wanted to get out of debt and get on track for an increased net worth as fast as possible.

Here we are several years later and we're now back on track. We have no debt (except a mortgage) and we're slowly building up a nice nest egg that includes savings, retirement accounts and insurance.

Here's are three things that we did that had the greatest impact in helping us to turn things around.

Start Tracking What You Spend And Set Up A Budget

The biggest change that we made was to actually start tracking what we were spending.  When we got to the end of the month normally we would be at the end of our bank account – with not much left over to save or pay extra on debts.  The money was just gone and we didn't really know where it had gone.

After reading Dave Ramsey's Total Money Makeover we started actually tracking where our money was going for a couple of months.  What we found was that we were overspending by huge amounts of money in our eating out category and in our entertainment spending.  There was a lot of room for making cuts.

Once we had tracked our spending for 2-3 months we actually set up a budget and cash flow plan at our house.  We started working on a zero based budget suggested by Ramsey where you allocate every dollar to either a spending, saving, investing or giving category before the money even hits the account.    You allocate every dollar, and if you have money left over at the end of the month – it needs to be re-allocated to a category. If the money isn't given a name and given a job – that money has a way of disappearing.

We quickly found that once we started using our budget, and not spending more than had been allocated in different categories (using a cash envelope system), we ended up having several hundred dollars a month left over that we hadn't had before.   And it wasn't like we ended up making any painful cuts or hard decisions.  That's quite a turn around!

Set Up An Emergency Fund

Another thing that made a huge difference for us, while we were paying off debt – and once we had it all paid off – was having an emergency fund. According to a Gallup poll a few years back, Only 10% say they have $1,000 in cash available in case of an emergency.  That's not good!

In the past I had always thought that having a credit card was just as good as having a cash emergency fund.    But what I realized later on was that using a credit card to pay for life's little “emergencies” just helps to continue a cycle of debt by creating new debt – when you could have instead planned ahead and had the cash to pay for it up front.

So how much should you save in an emergency fund?   It depends on what you want your level of security to be, and the amount of risk you want to take on by not having an emergency fund.  At our house, and in this economy, we currently have about a 10-11 month emergency fund (we can pay for 10-11 months of our expenses if we were to lose all income tomorrow).    We just aren't optimistic about where our economy is heading, and we want to make sure we're prepared for the worst.  While we were paying off debt we saved up $2000 in our emergency account because we figured that would cover most problems that could happen.

Try Living A Cash Only Lifestyle

The third thing that we did that had a huge impact was switching from a lifestyle financed by credit and loans, to one financed strictly by cash.  If we want to buy something now, we pay for it with cash.   Now that doesn't necessarily mean we pay for everything with crisp new $20 bills, but it does mean that we don't buy anything unless we have the cash on hand in our bank account to pay for it.

A couple of examples of how things changed in our life.

  • We needed some new furniture for our new house when we moved 4 years ago.  In the past we probably would have financed the furniture at the store or put it on a credit card.  Instead, this time we had planned ahead and saved the cash to pay for it up front.
  • Two years ago my car started having problems, and we knew we'd have to buy a new car to replace it.  Instead of buying an expensive model financed at the dealership as we had in the past – this time we had saved up enough money every month in a “car fund” to buy a nice used car – that was new to us.  A paid off car just drives so much nicer than one with a huge loan on it!

Paying cash and not having new debt is so much more freeing!

Planning  Ahead, Saving Up And Living Within A Framework

When you look at the three points above, they all have something in common.  They involve taking a look at your life, and making a decision to live with a plan, to thinking things through and making rational decisions that will pay off down the road.  They involve living with delayed gratification, and deciding that you want to make sacrifices today so that tomorrow will be a brighter day.  Making those types of decisions isn't always fun, but in the end it will pay off.

What other things would you suggest people do – or what are some things  that you have done that have made you more successful?  Tell us your thoughts -and your tips and tricks – in the comments!

How To Sell Your House Fast In A Tough Real Estate Market

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A few years back my wife and I were selling our townhouse, and the market was at it's height. Sellers were easily getting the asking price for their homes, and some were even getting more than one offer – sometimes above the asking price. Times were good if you were a seller, however, the problem was that if you were selling your home, you are also probably looking to buy a new home. We ended up selling our house for the asking price – and then we turned around and probably overpaid for our new home. If only we had known what the market would do, we could have waited a few years after selling – and bought a new home at a bargain. What's that they say about hindsight?

The market has now been going down for a couple of years, and homesellers are having a tough time selling their homes.   For many homeowners they bought their homes with little or no money down, and they're now finding themselves underwater on their mortgage – they owe more than the house is worth.  From bloomberg.com

Almost one-quarter of U.S. mortgage holders owed more than their homes were worth in the second quarter and that figure may rise to as much as 30 percent by mid-2010 as job losses and foreclosures climb, Zillow.com said.

With so many underwater mortgages many people are just walking away from their homes.  When those people walk away the banks end up foreclosing.   That means the market now has a glut of foreclosed homes on the market.    In fact accordingto RealtyTrac.com there has already been 1,654,634 foreclosures so far in 2010!

With all those foreclosures in addition to all the short sales, your competition is stiff.  You need to make sure to give yourself every possible advantage.  Here are some tips that will hopefully help you to sell your house fast.

9 Tips To Help You Sell Your Home

To help you sell your house in a down market, here are some things you can do.

  1. Your pricing is extremely important:  If you want to sell quickly when the market is bad, you might have to make some leeway when it comes to your price.  Many areas (including mine) have been hurt by all the foreclosures and short sales, and prices are depressed.  While you don't have to price your home like a foreclosure, you'll still want to figure out what a reasonable price in your area is, and try to undercut your competition if you can.  The price you give your house is one of the more important pieces – so try not to get emotionally stuck on a certain price you were “hoping to get”.
  2. Make sure it looks nice from the street:  While you can't always beat all the foreclosure and short sale homes on price, you can usually make sure your house has better curb appeal. The foreclosure home may have an un-cut lawn, scraggly plants and garbage in the driveway – while yours should be spotless. Get the home power washed, paint the trim and the doors, put on new exterior lights and/or knockers, and put in some nice new plants.   If the buyers don't like how your house looks on the outside, you might not even get them through the door.  If it does look nice, you'll give them a great first impression!
  3. Put all your junk away!:  When you’re living in a home, you end up having bills on the counters, photos of your family on the wall and all sorts of other personal clutter that has grown over the years.  But when you’re selling a home you want the people walking through the door to picture themselves being at home in your house.  Take down Billy's class photos for the past 10 years off of your living room wall, and replace them with a nice piece of neutral wall art.  Clean off your kitchen counters.  Take extra furniture and put it in storage.  Remove unnecessary items from the house in general and put them in storage to make the house feel bigger.
  4. Fix problems big and small:  If your house has a big problem of some sort that is glaringly obvious, get it fixed.  Broken window?  Put in a replacement.  Dirty carpeting?  Put in some new carpet.  Sometimes you can also have smaller problems that might not be so obvious, but that could still make a bad impression.  For example, when we sold our house we went around and repainted several rooms because of small marks and scratches on the wall. The result was that our house almost looked brand new!
  5. Stage your house to give a better impression:  We staged our home with my mother in law's help when we sold our home.  It made our home feel more spacious, made it feel less cluttered and allowed buyers to picture themselves in the home. We removed several larger pieces of furniture, and put some smaller plusher pieces from our parent’s houses in the living room.   We took our personal photos down and put up framed art pieces.  We removed all the magnets and photos from the fridge, and put some strategic accessories around.  We watched a lot of HGTV and picked up tips from the experts on how to stage our home.
  6. Give a bonus to buyers or agents: You might want to think about offering to pay the closing costs for a homebuyer, or offering a signing bonus for an agent who brings in a full price offer.  Some folks have even thought to offer things like pre-paying homeowner's association fees for a year or two.  Put your thinking cap on to think of bonuses, it doesn't have to cost a ton if you don't want it to.
  7. Use non-traditional means to market your house:  While listing your house with your agent is a good first step, try other online and offline venues to market your house.  Put up a craigslist ad and use sites like zillow.com or trulia.com.  Try buying a domain name using your house's address (1500ParkAve.com), and put up a wordpress site to post pictures and details about your house.   Let people you know that the house is for sale and post it to Twitter, Facebook and other social media outlets.  Put up flyers at the local supermarket!
  8. Find a good agent who will help you sell:  Selling your house is one of the biggest financial transactions you'll have.  It's not a good time to do your crazy uncle Bob who just got his real estate license a favor and let him sell your house, especially if he's not a good agent.   Call some agencies and ask for their top salesperson.  Get a good word of mouth recommendation and interview a few agents and ask them what their marketing plan for your home would be.  Use someone who knows how to market on the internet, the importance of good wide angle interior photos, and someone who understands your particular market.
  9. Keep your house clean for when it shows -and don't be there!:  One of the things I hated doing while we were selling our house was keeping the house clean at all times in case there was a showing.  It stunk, but it paid off.  We also made sure not to be at home when the house was showing, because buyers hate nothing more than feeling like the owners are staring at them as they check out the house.  Finally, consider doing some baking before a showing, or light one of those cinnamon roll candles. Anything you can do to make people feel at home is a plus.

Getting your house sold when the market is this tough isn't going to be an easy prospect – but it can still be done.  Just follow the tips above, have a little bit of patience, and you'll be well on your way to putting that sold sign in your front yard.

Have a tip for something you did that helped your home sell fast?  Tell us about it in the comments!