Flexible Spending Accounts (FSAs) are a way to save money by using pre-tax dollars on out-of-pocket medical expenses. FSAs are purely job-based, are not available to the self-employed, and do not transfer if you leave your job. Unlike Health Savings Accounts (HSAs) that are considered your money to transfer as you need, FSAs are considered the employer’s money until you draw it out for use.
If your employer offers an FSA, you can choose an amount of FSA money to be set aside from your paycheck (up to $2,550 as of 2015). You will be issued a debit card preloaded with your designated amount, and the card can be used to pay various medical and dental expenses tax-free.
For the most part, FSAs may be used for any expenses that could be claimed under the itemized medical expenses deduction on Schedule A (Form 1040). A detailed list of those expenses may be found at IRS Publication 502, Medical and Dental Expenses. The list is extensive, covering most non-cosmetic procedures.
FSAs may be used for co-payments for medical visits, deductibles, and for prescription medications. Over-the-counter medications may also be covered if there is a corresponding doctor’s prescription for them.
There may be exceptions in your plan and rules may change – verify with your plan before assuming any specific expense is covered.
The downside of an FSA is that you are expected to spend the money in this plan during a specified 12-month period (typically the calendar year). Generally, you lose any unused portion of the year’s FSA. However, employers do have the option of either allowing you one of two choices – rolling over $500 to the next year's total or taking an extra 2-1/2 months to spend the previous year's total.
However, if you plan properly there is no reason to leave unspent funds in your FSA.
- Review Previous Year’s Expenses – If you have no idea of your typical medical costs, you are likely to under or overfund your FSA. Take the time to review last year’s allowable expenses as a starting point.
- Choose Your FSA Amount – Start with last year’s expenses and adjust for any known future expenses, such as upcoming orthodontia for your kids or a known increase in co-pays.
- Track Your Costs – Track all your FSA costs throughout the year and keep receipts. Not only will this help you distribute your FSA funds properly and monitor your balance, it will help you in case there are any disputes.
- Plan Visits Ahead When Possible – You cannot plan illnesses – and why would you if you could? However, many covered expenses are predictable in advance – for example, medical check-ups. Early scheduling of checkups can keep you from scrambling to spend FSA funds at year’s end.
If you wait to cram multiple medical checkups and dentist appointments into the end of the year, you may find there are no appointments available until after your card expires.
Where does unspent money go? It goes back to your employer. Under IRS rules, your “share” of the money cannot be given back to you directly, but it can be used to pay the overhead expenses involved in running the FSA. The collective unspent money can be distributed equally among all employees if the company wishes.
With suitable planning and some luck, your FSA will cover the majority of your out-of-pocket medical and dental expenses without causing a loss of funds at the end of the year. If you do end up with leftover funds, just learn your lesson and plan better for next year.