If you think you're paying a lot for healthcare expenses, you're right. Researchers at Milliman have recently estimated that the typical American family of four spends about $6,408 annually on premiums and $4,065 on out-of-pocket expenses. Ouch!
Fortunately, there are some strategies you can employ to reduce your healthcare costs, and one prime example is the Flexible Spending Account.
What it is
With a Flexible Spending Account (FSA), your employer sets up a dedicated account for you and diverts some of your salary into it on a pre-tax basis. Some employers will also contribute money to it. You can then pay for a wide range of qualified healthcare expenses -- including prescriptions, deductibles, and copayments -- with those untaxed dollars. Nice, huh?
Of course, it's not quite as simple as that. For starters, the amount you can contribute to a Flexible Spending Account is capped, and for 2015, it's $2,550. (It's adjusted for inflation regularly.) If you follow the rules, then your contributions are never taxed. So if you contribute the full $2,550 and you're in the 25% tax bracket, then you avoid paying almost $640.
Clearly, your potential tax savings are significant. You generally decide how much to put in your FSA once a year during open enrollment season, and then small amounts adding up to your total contribution will be withheld from each paycheck.
Deciding how much to contribute to a Flexible Spending Account is a trickier decision than you might have thought, because they have a catch: You have to use the money within the plan year -- or else you lose it. So it's important to estimate your annual contributions as accurately as you can.
There are two ways your employer may be able to help if you don't spend the money in the account on time. Your employer might extend the spending deadline by up to two-and-a-half months, or it might permit you to carry over up to $500 to spend in the following year. However, your employer may not offer either option, so find out the rules before moving money into an account.
To use an FSA, you typically receive a debit card tied to the account to use for qualifying expenses. You may also receive blank checks, and you can often pay for expenses on your own and then get reimbursed for them from your FSA account.
What's covered and what isn't
As noted above, prescriptions, deductibles, and copayments are expenses that you can pay for through your Flexible Spending Account. Your health insurance premiums do not qualify.
Here are some more expenses that can qualify: acupuncture, artificial teeth, bandages, birth control pills, breast pumps and supplies, breast reconstruction surgery, chiropractor services, contact lenses, dental work, diagnostic devices, drugs, eye exams, eyeglasses, fertility treatment, hearing aids, home care, lab fees, lead-based paint removal, lodging needed for medical reasons, medically necessary home improvements, long-term care, oxygen, psychiatric care, smoking cessation programs, therapy, transplants, vasectomy, some weight-loss programs, wheelchairs, wigs, x-rays -- and more.
Note that the expenses above don't always automatically qualify. For some, you'll need a letter from your doctor explaining that they're medically necessary for you. For others, the expenses may be only partially allowed. For instance, if you're traveling to a hospital for an eligible kind of care, you can pay for $50 per night per person with your FSA money.
Of course, many expenses are simply not allowed. For example: child care for a healthy child, cosmetic surgery, dance lessons, diapers, gym memberships, hair removal, maternity clothes, many nonprescription drugs, nutritional supplements, teeth whitening, and veterinarian services.
Think about the health-related expenses that you and your household incur and look each one up (this IRS guide is helpful) to see whether it qualifies and whether there are any rules or restrictions. That can give you the best idea of how much money you'll likely need in your FSA for the year. It can be helpful to go through your past year's checkbook and credit card statements to be reminded of out-of-pocket health-related expenses paid.
There are actually several kinds of Flexible Spending Accounts. The kind detailed in this article is the one meant for health-related expenses, and it's the one people are most likely to use. Some people, however, might be well served by the Dependent Care Flexible Spending Account (DCFSA). It aims to help people with expenses related to taking care of dependents who are young children, special-needs children, or elderly so that the account holder can go to school full-time, work, or look for work.
There are two other kinds of FSAs that you might run across. One is offered by some employers who don't offer health insurance to workers, and it helps workers pay for insurance premiums. Another kind offers assistance with expenses tied to the adoption of one or more children. If any of these kinds of FSA accounts seem like they might be useful to you, then ask about them at your workplace.
What the FSA is not
It's important to understand what an FSA is so that you can make the most of it. It's also critical, however, not to get it confused with other tax-advantaged plans -- such as the Health Savings Account (HSA). According to a 2013 Fidelity survey, fully 73% of Americans were confused about the two and didn't understand critical differences.
Here's the Health Savings Account in a nutshell: It's another employer-sponsored account meant to help with health-related expenses, but it's only available to those who have a high-deductible health insurance plan. (The deductible must be at least $1,300 for single folks and $2,600 for those with family coverage.) Participants must also not be covered by any other health insurance plan that doesn't have a high deductible, must not be enrolled in Medicare, and cannot be claimed as a dependent by anyone on his or her tax return.
The Health Savings Account has heftier contribution limits -- up to $3,350 for singles and $6,650 for households in 2015, and those aged 50 or older can contribute up to $1,000 more. Better still, unlike Flexible Spending Accounts, these are not use-it-or-lose-it accounts. Whatever isn't spent can be carried over into future years and can even be saved for retirement expenses.
Indeed, HSA money can be invested in mutual funds and other kinds of investments designed to grow. In many ways, the Health Savings Account is preferable -- and can even make it worth switching to a high-deductible insurance plan in some cases. But for the many people who don't have such a plan and for whom it doesn't make sense -- such as those who make heavy use of medical services -- the Flexible Spending Account can be a great help.
Here's a critical detail to know: If you're interested in using a Health Savings Account, you can't do so in the same year that you have a healthcare Flexible Savings Account. Furthermore, if you carry over money from one year to the next in an FSA, that will disqualify you from having an HSA in that second year, too.
Strategies and tips
If you're interested in making the most of a Flexible Savings Account, then be strategic about it. Be sure not to park more money in your account than you know you can spend in the year.
If your needs fluctuate from year to year, then be conservative in your estimate. If you know you have a lot of expenses coming up, then consider maxing out your account.
As the end of the year approaches, if you have too much money left in the account, don't simply prepare to forfeit the money. Try to spend as much as you can.
Perhaps stock up on qualified supplies such as bandages or blood glucose-testing devices. Perhaps replace old medications in your medicine cabinet with fresh ones via new prescriptions. Get a snazzy new pair of glasses. Stock up your first-aid kits and perhaps get a blood-pressure testing machine if you don't have one. If your child is getting braces early in the new year, then see if the appointment can be moved up to late December. There are many possibilities.
A Flexible Spending Account can save many people more than $600 per year, so it's well worth learning more about it. Ask your employer if such an account is offered and how you might sign up for it if it makes sense for you.