A Health Care Flexible Spending Account (FSA) can save you thousands of dollars via tax deductions each year in an effortless manner. While many employers offer the Flexible Spending Account as an additional perk, many employees simply don’t take advantage of it. The reasons vary from lack of understanding to downright apathy since it’s something that’s not automated and requires some basic estimation and a lack of instant gratification because you won’t see the benefit until the end of the tax season each year.
How an FSA Plan Account Works
IRS rules for FSA plans allow health-related expenses to be deducted each year so long as they are classified as qualifying expenses, which are outlined in detail below. At a high level, an employee establishes a pre-determined amount of money to be set aside from their paycheck each period to be designated an an FSA contribution, of which the total annual amount is deducted from the annual payroll calculation for tax purposes. So, if you anticipate $4,000 in health-related savings in a given year and utilize the system appropriately, you will be taxes at $4,000 less than you would have otherwise. For a 25% marginal tax rate, that’s $1,000 back in your pocket at tax time for simply playing within the system.
Generally, at the end of a calendar year, employers that offer a Flexible Spending Account will notify employees that it’s time to establish their FSA contribution limits. Note however, that if you overestimate your anticipated eligible health related expenses for the next year, you actually lose that money! It seems rather counter to the whole spirit of empowering employees to take an active part in their health expenses in that if they “guess” too high, they lose money and if they “guess” too low, they don’t get an optimal tax deduction, and hence, lose money. Ideally, you’d be able to just deduct all your health-related expenses for a given year up to a reasonable cap, but there’s no pending legislation with any traction in that regard.
Step by Step Example FSA Administration:
- ~November Year 1, Employer requests that you estimate your withholding and commit to have that annual amount divided by 12 removed from your monthly paycheck (biweekly or whatever)
- Starting on your first paycheck of Year 2, you’ll notice funds withheld from your paycheck going into an FSA.
- By the end of the year, I seek to optimize my health related expenses to hit the targeted contribution amount.
- ~January Year 3, I get a form from my health insurer asking me to submit proof of my eligible health related expenses for reimbursement (this can also be done electronically along the way with a particular health charge card, but I haven’t spent the time to set it up). About 2 weeks later, I get my check for the exact amount.
- For now, it seems like a wash right? You put in $2,000, get back $2,000. Well, now it’s tax time.
- ~March Year 3, file tax return and note that $2,000 was utilized in the FSA. ~2 weeks later, receive tax refund, of which additional $2,000*marginal tax rate is included above and beyond my normal deductions, for say, a savings of $500.
- That’s essentially $500 per year in cash back for virtually no effort – just follow the simple steps below to establish a system for estimating and tracking your eligible health spending items.
Some helpful hints on establishing your FSA contribution for the next year:
- Keep a file with all your health-related expenses each year. This should establish a pretty good baseline for what health-related spending will look like in future years (with absurd 6-8% inflation of course!)
- Keep every receipt. As you’ll see below, a seemingly routine trip to CVS could be a tax deduction – like band-aids for instance.
- Consider significant one-time expenses and whether they will or won’t fall into the next calendar year. An example might be a couple that buys new glasses every 3 years. My wife and I each buy a pair of regular prescription glasses and a pair of sunglasses for a total of 4 sets every few years. If your eyesight isn’t changing and you don’t have children that routinely mangle your glasses, this is an expense you’re spared on a recurring basis!
- Try to pull or push large one-time expenses into an optimal year. With the eyeglass example above, if it’s December and you’re $300 from your limit still, consider buying a few pairs of glasses in the current year so you don’t lose those dollars. If you’re already over the limit and know you’ll need new glasses soon, push it to next year.
- Really work to estimate and ask your provider about anticipated expenses for child-birth. This was a significant expense, even with 90/10 coverage that got us one year where I wished we had contributed more to the FSA. Another afterthought in that regard was that childbirth would have qualified as a “life-time” event, in which some employers allow for a mid-year change in contributions – which I was not aware of until after the fact.
- Really, really understand what your eligible expenses are and what doesn’t qualify – below.
- I rely on cash-back credit cards for as many expenses as I can and NEVER carry a balance (that’s the catch!). But, by doing so, we get back hundreds of dollars per year in tax-free income for doing nothing but carrying less cash around and exercising discipline. The Best Card around is Chase Freedom with 5% cash back in rotating categories and 1% cash back on everything else, especially while many other card companies have eliminated cash back rewards.
FSA Eligible Expenses
You’d be surprised by the sheer number of expenses that are considered to be “eligible” for tax deduction purposes. Here’s a partial list of eligible expenses that you’ll possibly incur each year or on a one-time basis that you’ll want to take advantage of annually:
- Annual Physical Examination
- Artificial Limb
- Artificial Teeth
- Body Scan
- Breast Reconstruction Surgery
- Birth Control Pills
- Braille Books and Magazines
- Capital Expenses
- Christian Science Practitioner
- Contact Lenses
- Dental Treatment
- Diagnostic Devices
- Disabled Dependent Care Expenses
- Drug Addiction
- Eye Surgery
- Fertility Enhancement
- Guide Dog or Other Service Animal
- Health Institute
- Health Maintenance Organization (HMO)
- Hearing Aids
- Hospital Services
- Insurance Premiums
- Intellectually and Developmentally Disabled, Special Home for
- Laboratory Fees
- Lead-Based Paint Removal
- Learning Disability
- Legal Fees
- Lifetime CareÃ¢â‚¬â€Advance Payments
- Long-Term Care
- Medical Conferences
- Medical Information Plan
- Medical Services
- Nursing Home
- Nursing Services
- Organ Donors
- Physical Examination
- Pregnancy Test Kit
- Psychiatric Care
- Special Education
- Stop-Smoking Programs
- Vision Correction Surgery
- Weight-Loss Program
Yes – even a wig! The forgoing list is the majority of all eligible health spending account expenses.
FSA Excluded Items:
- Baby Sitting, Childcare, and Nursing Services for a Normal, Healthy Baby
- Controlled Substances
- Cosmetic Surgery
- Diaper Service
- Electrolysis or Hair Removal
- Flexible Spending Account
- Funeral Expenses
- Future Medical Care
- Hair Transplant
- Health Club Dues
- Health Coverage Tax Credit
- Health Savings Accounts
- Household Help
- Illegal Operations and Treatments
- Insurance Premiums
- Maternity Clothes
- Medical Savings Account (MSA)
- Medicines and Drugs From Other Countries
- Nonprescription Drugs and Medicines
- Nutritional Supplements
- Personal Use Items
- Teeth Whitening
- Weight-Loss Program
For the full list of even more obscure items and their descriptions, visit the IRS website for more details.
What About You? Did I Miss any Helpful Hints or Information Regarding FSA Plans?
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