With healthcare costs continuing to climb for working Americans, finding ways to make medical care more affordable is in everyone's best interest. Thankfully, most companies make it easy for employees to shave money off their healthcare expenses by offering a flexible spending account, or FSA.
There are two types of FSA -- healthcare and dependent care. With the former, which we'll be discussing here, you can allocate pre-tax dollars to pay for medical expenses like doctor visit copays, prescriptions, and approved health-related equipment or supplies. With the latter, you can set aside pre-tax dollars to cover the cost of child care.
Though the annual contribution limit for dependent care FSAs isn't rising in 2020, those who save in a healthcare FSA will get the option to contribute more money next year. Whether you should do so, however, depends on what your medical expenses look like.
How healthcare FSAs work
With an FSA, you contribute money that's taken out of your earnings on a pre-tax basis, and the amount you contribute is income the IRS won't tax you on. For the current year, the maximum amount you can contribute is $2,700, but come 2020, that limit will rise to $2,750. That's good news if you tend to max out your FSA and still spend money on healthcare above that limit.
That said, there is a major drawback to saving in an FSA, and it's that funds go in on a use-it-or-lose-it basis. This means that if you contribute $2,750 to your FSA next year, but you only rack up $2,250 in eligible medical expenses by the time your plan year expires, you'll risk forfeiting your remaining $500.
Be careful when funding an FSA
FSAs are a great way to lower your tax burden, thereby freeing up money you can use to cover healthcare expenses. But you really don't want to overfund your account, because if you do, you risk kissing that money goodbye.
The solution? Comb through your health spending records from the past two years to see how much you actually paid for medical expenses, and then use those numbers to guide your upcoming FSA contribution. If, for example, you racked up $2,900 in medical expenses in 2018 and are already at $3,000 for the current year, then you're probably safe to max out your FSA next year. But if your healthcare spending in the past two years has averaged $1,200 annually, maxing out next year could be a bad move. The only exception is if you expect your healthcare costs to go up for a specific reason -- say, you're having a baby, planning to undergo fertility treatments, or have a child who will be getting braces.
It also helps to familiarize yourself with the expenses that are FSA-eligible. You can consult this list to see which purchases can be made with FSA funds, because it could be the case that you currently spend money on items you didn't know qualified (like sunscreen, for example).
One final thing: Though you're generally required to deplete your FSA balance once your plan year is up or risk losing that money, most plans these days offer a bit more flexibility. There's a good chance your FSA will either give you a couple of extra months to use up your balance once your plan year expires, or allow you to carry a certain portion of your balance into a future plan year rather than give it up. Pay attention to these details when you sign up for your employer's FSA, because they'll help you decide how much money you're safe to contribute.