Healthcare Flexible Spending Account

by Glenn J. Downing, MBA, CFP®

Do you have a Flexible Spending Account available to you through work?  These can offer tremendous tax savings.  As you do your research, note that FSAs are of two sorts:  The Healthcare FSA and the Dependent Care FSA.  

Flexible Spending Accounts (FSAs)

A flexible spending account (FSA) is offered as an elective benefit by many employers.  This is part one of a two-part series. Here I describe the healthcare flexible spending account. You’ll find my post on the dependent care FSA here.

The Healthcare FSA

This account allows workers to contribute, through payroll deduction, to accounts that are designated for qualifying medical or dental expenses not covered by insurance. All amounts contributed are pretax and funds are not taxed when spent on qualifying health care costs – this is a big tax advantage. The FSA owner can use the funds for deductibles, co-payments, and co-insurance for the employee’s health insurance. The funds are also available for dental and vision expenses. Over-the-counter medications are not an allowable FSA expense, but prescription drugs are.

Before the new tax year the employee directs the employer to reduce his salary by a certain amount, up to a $2750 limit (2020). These salary reductions are not subject to income tax, nor to payroll taxes. The employee then makes a claim on the plan for reimbursement. Participants are commonly provided with a debit card from the FSA account. Any charge that is not covered won’t go through. Here’s an example: you purchase a $10 Rx at Walgreen’s, and a $3 can of shaving cream. You present your FSA debit card at the register. The card will cover only the $10 for the Rx, but you’ll be prompted to submit an alternate tender for the shaving cream.

Use It or Lose It

Here’s the rub – you must use the funds in your healthcare FSA each year. Only $500 can be carried forward into a new year - if the employer allows it.  The employer can also offer a grace period, giving the participant up until March 15th of the following year to use the funds.  The employer can offer only one of these two options, or none at all.  Generally, If there is a balance in your account at the end of the year, you lose it.  So the idea is to match carefully withholding with anticipated medical expenses.

Make It Work For You

How can you make a healthcare flexible spending account work for you? Say you take a prescription that costs $20/month. You also see a chiropractor monthly, costing $45 each visit. Medical insurance won’t cover the chiropractor. You are therefore out of pocket ($20 + $45)*12 = $780/year. You would therefore have $780 withheld into your healthcare FSA. If you are in a marginal 24% tax bracket, you’d save that, plus the 7.65% payroll tax, for a total savings of $246.87. Worth the bother, I’d say!

Your entire annual contribution is available for your use at the beginning of a new plan year – even though, as in the example above, you wouldn’t have funded the entire contribution yet. If you do use up the entire amount available early in the year, and then leave to go to another employer, the deficiency is not payable by you.  And don't cry for the previous employer.  Remember, he retains unused balances that don't carryover.  

Say you are in the open enrollment period, and your dentist finds $4000 of dental work that needs doing soon. You choose to have $2750 – the maximum – withheld into your healthcare FSA. Come January the entire $2750 is available to you, even though you have not yet contributed towards it. The following July you decide to change jobs. Clearly you won’t have contributed the entire $2750 yet, but there is no repayment of the funds that were advanced to you.

Be sure not to confuse the Healthcare FSA with a Healthcare Savings Account, or HSA.  That is another type of tax-advantage account that works with your employer's high deductible healthcare plan.  

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