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Flexible Spending Accounts

December 7th, 2007 at 02:32 pm

If your company offers a Flexible Spending Account (FSA), consider signing up for it in 2008. With an FSA, you request a “salary reduction” to fund the FSA. The FSA funds can be used to pay for qualified medical expense and/or for dependent care. Dependent care is usually used for child care expenses, but may also be used for adult day care for senior citizen dependents, such as parents, if they live with you.

The advantage of using FSA funds to pay for qualified expenses is that the amount used to fund your FSA is not subject to federal, state or payroll (FICA) taxes. If you are in the 25% federal tax bracket, with a state income tax of 5% and a payroll (FICA) tax of 7.65%, you will effectively be able to buy your health care and dependent care services at a discount of 37.65%.

The maximum funding amounts allowed by the IRS are $5,000 for medical care and $5,000 for dependent care. Assuming you are in the 25% federal tax bracket and have 5% state taxes, $10,000 total funding would yield a tax savings of $3,765, providing a 37.65% “discount” on the purchase of these services.

Be careful not to overestimate your FSA requirements. Any funds remaining in your FSA, at the end of the benefit coverage period, will be forfeited back to the company.

5 Responses to “Flexible Spending Accounts”

  1. Broken Arrow Says:

    My employer offers it, but truth be told, I'm not convinced. However, this is in light of the fact that my credit union also offers an HSA that indeed rolls over.

    That said, I agree that if you have an HDHP, it's worth looking into such an account. If you're stuck with a FSA, I'm of the current opinion that perhaps it would be best to keep only the minimum average of your annual healthcare expenses.

    Once again, another well-written article. Smile

  2. finabguide Says:

    If you have access to both an FSA and an HDHP/HSA, you might consider the following strategy.

    Fund your HSA to the maximum extent possible ($2,850 if you are single or $5,650 for couples in 2007).

    Now, fund you FSA to the extent of medical expenses that you are fairly certain that you will need. Remember this includes virtually any medical expense including glasses, dentists, chiropractic, medicines (both over the counter and prescription) etc. Use your FSA funds to pay for these medical expenses. When the FSA runs out, you can then use the HSA funds.

    If you use very little or none of your HSA funds,they will grow on a tax free basis and can be used (tax free) on any future medical expenses.

    In my book, I have a section showing how this approach can lead to a retirement with virtually no out of pocket medical costs.

    Thanks for you kind comment.

  3. Broken Arrow Says:

    An interesting suggestion! So, does that mean the maximum contribution is limited only to PER ACCOUNT? As in, as a single, I can contribute $2850 PER ACCOUNT? Or is the $2850 the absolute limit per year, regardless of how many accounts I have?

  4. finabguide Says:

    If by Account you mean FSA or HSA, they are completely separate entities.

    When you fund the FSA, you do so through a "salary reduction." The IRS maximum allowed for health care is $5,000 per year. Employers sometimes allow a lesser figure. With a salary reduction, you pay no taxes on the FSA amount withheld, even payroll (FICA) taxes.

    An HSA requires that you have a qualified High Deductible Health Plan (HDHP). As long as you have the HDHP for the full year, you may deposit $2850 (2007)into your HSA. The HSA is tax deductible, and grows tax free, just like an IRA. However, when you withdraw HSA funds for medical expenses, the withdrawal is ALSO tax free, like a Roth IRA.

    You might want to check out my web site www.financialabundanceguide.com I have articles on various free financial planning strategies including HSAs available there.

    Hope this helps.

  5. Broken Arrow Says:

    Huh. Yes, I didn't realize those particular differences between the two. Thank you for clearing that up!

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