If your health insurance plan provides a Flexible Spending Account or FSA option I highly recommend you use it. You are getting a tax break for every dollar you put into the account. If you use those dollars toward eligible healthcare expenses then you never pay taxes on that money.
Yes, you read that correctly. Remember that old saying?
Our new Constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes.
-Benjamin Franklin
Use your FSA and you’ll only have to worry about the death part of that classic quote. Inspiring, right?
In all seriousness this is a potentially huge benefit if you use your FSA correctly. When else in your life have you been able to completely avoid income tax on your wages?
But pay attention because you can easily screw this up and pay a lot of money in taxes — or forfeit the money left in your account!
Use Your FSA Funds by the End of the Plan Year
Flexible Spending Account funds must be used by the end of the plan year. Period. No exceptions.
The plan year might be different from the calendar year. It depends on your health insurance. Many plans run January 1 – December 31, but check with your human resources department (or the health insurance firm directly) to verify the date that you use all your FSA funds.
Why should you worry about using the funds? If you fail to use the money in your Flexible Spending Account by the end of the plan year you forfeit that money. Poof! It’s gone. Out of your account and into the plan’s administrative budget plans. (These funds are also sometimes given back to all plan participants as income. Maybe you could ask all of your co-workers for some of your money back.)
Losing your FSA funds to the plan administrator would be a classic example of Dumb Money. You’ve done the right thing by using the FSA. Remember to follow through by actually using the funds and not giving them away for free. That’s worse than not paying taxes on the funds!
Use Flexible Spending Account Funds on Eligible Expenses Only
When you use your FSA account (most likely with a plan managed debit card) you can use the funds in two different ways: on eligible expenses, and on ineligible expenses.
As you might expect eligible expenses is the only thing you should use these funds for. The whole eligibility thing means it’s okay for you to use the funds — you don’t pay any taxes or fees by using the funds. (Eligible expenses are those that are allowed for deduction for tax purposes. You can find the list at Publication 502 at IRS.gov.)
On the other hand, ineligible expenses, aren’t something you want to use your flexible spending account funds for. You’ll end up paying taxes on those funds because you didn’t use them for eligible healthcare expenses.
FSA Eligible and Ineligible Expenses
So what items fall into what category?
A handful of eligible expenses:
- Co-pays to doctors, dentists, etc.
- Allergy medicine
- Flu shots
- Guide dog (adoption, training, etc.)
A handful of ineligible expenses:
- Adoption fees
- COBRA premiums
- Diapers
(Check out a pretty comprehensive list at Wage Works, a large FSA/HSA provider.)
FSA Eligible Expenses Change in 2011
If you have an FSA it is critically important that you know how much, on average, you spend on healthcare during a given year. If you only spend $500 per year then don’t set up the account to be funded with $2,000. You will be scrambling at the end of the year to find qualified expenses, or you’ll end up losing a huge chunk of cash.
In the past if you looked at your FSA account balance on December 28th and noticed it still had money in it you would have time to run down to the drug store and stock up on over the counter cold medicine and pain relievers. Sure you might not use them for several months, but it was better to stock up than to forfeit that money.
Recent changes in healthcare law have changed that, and I’m seeing this notice across multiple FSA company websites:
Starting January 1, 2011, you will not be able to use these spending accounts to pay for most over-the-counter drugs and medicines unless you have a doctor’s prescription. You will not need a prescription for insulin and diabetic supplies.
Tomorrow is October 1st. Check your FSA account balance today and start planning to use those funds up before the end of the year gets here. It’ll be here before you know it.
{ 1 comment… read it below or add one }
It does not seem like an FSA is a good way to go. What if one sets his yearly amount low and that year has major problems?