How Does A Flexible Spending Account (FSA) Work?

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!