If you're like most workers, your attitude with regard to employer benefits is probably something along the lines of "the more, the better." Yet a surprising number of employees don't take advantage of one key tax-saving benefit: the flexible spending account. Here's what you need to know about FSAs in 2018 -- and why it pays to sign up for one going into the new year.
How flexible spending accounts work
FSAs come in two varieties: healthcare and dependent care. Both options work the same way in that you contribute a specific amount to your account, rack up eligible expenses, and then get reimbursed (or, in some cases, get to debit that amount from a prepaid account so you're not actually stuck waiting for a refund of sorts).
Keep in mind that the amount you commit to during the enrollment process is the amount you're stuck with for the duration of your plan year (which typically coincides with the calendar year). If, for example, you decide to contribute $500 to an FSA and then come to realize later on that that's not enough, you can't go in and add more. Similarly, once you decide on a certain amount, you can't change your mind later and reduce your contribution. The only exceptions are when qualifying life events occur during your plan year, such as getting married, getting divorced, or having a child.
Healthcare FSAs are used to pay for expenses such as medications, doctor office visits, and medical equipment (think blood sugar monitors and the like). Over-the-counter medications are also eligible for FSA reimbursement, but you need a prescription to qualify. Dental expenses like cavity fillings and checkups are also covered under FSAs, as are prescription contact lenses and eyeglasses (including sunglasses). Dependent care FSAs, meanwhile, are used to pay for child care expenses such as day care, preschool, or summer camp that enable you and your spouse, if applicable, to work or look for work.
FSA contribution limits for 2018
One major change that will hit next year is that the annual contribution limit for healthcare FSAs is going up by $50 for a total of $2,650. The limits for dependent care FSAs, meanwhile, are holding steady at $5,000 for single tax filers and married couples filing jointly and $2,500 for married couples filing separately.
Why fund an FSA in 2018?
The main reason to participate in an FSA is to reap the tax savings involved. FSAs allow you to pay for expenses you're already incurring, only with pre-tax dollars, as opposed to post-tax income. Your ultimate savings, therefore, will depend on the amount you opt to contribute coupled with your effective tax rate.
Let's assume you max out both your healthcare and dependent care FSA next year for a total of $7,650. If your effective tax rate is 30%, that decision will shave $2,295 off your tax bill. And that's not a bad deal.
Drawbacks of funding an FSA
At this point, you're probably thinking, "Well, if FSAs are so great, why doesn't everyone open one?" The reason why participation rates aren't at their strongest is that FSAs typically work on a use-it-or-lose-it basis. This means that when you put money into your account, you're taking the risk that you won't incur enough eligible expenses to deplete your balance, thus creating a situation where you're forced to forfeit money.
Thankfully, FSA rules have evolved to protect participants from such losses. Though not every company allows workers to preserve unused FSA funds, some give participants more flexibility via one of the following options:
- A $500 carryover, which allows participants to roll that much money into the upcoming plan year (without that sum counting toward their total contribution)
- A 2 1/2-month grace period, which allows participants to incur eligible expenses for roughly another 10 weeks once their plan year has come to a close
Of course, your best move is to do a good job of accurately estimating your healthcare and dependent care expenses for the year so that you don't run into a situation where you're struggling to deplete your account balance. But if your company offers one of the above protections, you'll go in with less risk.
With the future of tax reform being rather uncertain, it pays to take advantage of tax breaks while you can. For the time being, FSAs are a fixture of employer benefits, so if you've yet to sign up for 2018, be sure to get on that immediately.