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Flexible Spending Accounts, or FSAs, are a great way to pay for health care costs and save money at the same time.
This works by having you save money through payroll deductions and then paying for eligible medical expenses with tax-free dollars.
But there are other benefits for FSA accounts, as well as cons of FSAs.
In this post, I walk you through the biggest pros and cons of flexible spending accounts so you can decide if enrolling in one makes sense for you.
Table of Contents
10 Pros And Cons Of Flexible Spending Accounts You Need To Know
5 Pros Of Flexible Spending Accounts
There are many advantages to flexible spending accounts.
Here are the ones that have the biggest impact on your finances.
#1. Tax Free Healthcare Expenses
The biggest benefit to flexible spending accounts is the ability to pay for healthcare expenses tax free.
This is because when you open an FSA account, the money is taken from your paycheck first, before taxes.
It is just like with your 401k plan contributions.
Your FSA contributions are taken first and you are taxed on the remaining balance.
The money that you save in your FSA sits there until you spend it or the end of the year, whichever comes first.
When you do spend the money on qualified medical expenses, the money is not taxed.
Therefore, you completely avoid paying any tax with this money.
#2. Lower Taxable Income
I mentioned this above but don’t want to overlook this benefit.
Since the money you contribute to your flexible spending account comes out before taxes, it lowers your taxable income, which means you pay less Federal income tax.
For example, let’s assume you are in the 25% tax bracket and your paycheck is $1,500.
If you didn’t contribute to an FSA account, you would pay $250 in income tax and your net take home pay would be $750.
Note I am simplifying things here to make it easier to follow along.
Let’s say you decide to open an FSA account and contribute $100 per paycheck.
You get paid $1,000 but $100 is taken for your flexible spending account.
This means you are now taxed on $900.
You pay $225 in income taxes and your net income is $675.
You saved yourself $25 in taxes by doing this.
#3. Access To Funds Immediately
Here is a great advantage that many people overlook.
Let’s say you decide to save $1,000 in your FSA account over the course of the year because you have a medical procedure coming up.
Since you get paid twice a month, $41.66 is taken from each paycheck.
When March comes along, you only have $166.67 of FSA funds in your account but you have the procedure done for $1,000.
Because you are contributing $1,000 for the year, your FSA will pay the balance due.
For the remainder of the year, the money you contribute will simply go towards the bringing your account back to zero.
And here is the best part.
Let’s say in June you leave the company.
You are not responsible for the any money that is still owed in the FSA account.
#4. Debit Card Makes Spending Easy
Most flexible spending accounts offer an FSA debit card to make paying for medical services and expenses easier.
In the past, you had to pay the bill out of pocket and submit the receipt and paperwork.
Then you would get reimbursed once the charge was approved.
Now you can skip this hassle and simply swipe your debit card.
Of course, you still have the option to submit claims the old fashioned way if you prefer.
#5. Different Types Of FSA Accounts
Another advantage of flexible spending accounts is there are different types of accounts and you can enroll in multiple ones at the same time.
The Healthcare FSA is the one this post is covering.
Another type of account is the Dependent Care FSA.
This plan is used to help pay for dependent care expenses.
This includes things like child care, from in home babysitting to day care and preschool, as well as adult care.
The plan works the same in that you save pretax dollars and pay for the services tax free.
Another type of plan is a Limited Expense Health Care FSA.
This account is specifically for dental and vision expenses and is not as popular as the other two listed plans.
For most people, the traditional FSA will be enough since that covers dental, vision and other medical expenses.
These are not to be confused with health savings accounts.
HSA accounts are similar to an FSA but you need a high-deductible health plan to be eligible for one.
An FSA is an option with most HMO and PPO health insurance plans.
Another difference is you don’t need to use the money in your HSA during the calendar year.
You can save the money and even invest it for future use.
5 Cons Of Flexible Spending Accounts
Some of the drawbacks of flexible spending accounts can be serious, including losing the money you saved.
Here is what you need to know before you opt into one.
#1. Need To Use Money During Calendar Year
With a flexible spending account, you need to use the money you save in the plan during the calendar year.
If you don’t, you lose the unused funds in the account.
For example, if you contribute $1,000 to your FSA and only spend $800, the remaining $200 is lost forever.
The catch to this is some plans allow for a two and a half months grace period to use your FSA money.
So instead of needing to spend the money in your account by December, you now have until March 15 of the following year.
The problem here is it further complicates things.
This is because you typically have open enrollment in December, which is when you have to determine how much you want to save for next year.
Since some of your costs could be used for last years FSA plan, you could end up contributing more than you need.
#2. Need To Estimate Annual Spending
As a result of the possibility of losing money in your FSA, it is important you estimate your annual spending.
While this is not hard to do, it can be complicated since you are guessing at how much money you will spend on healthcare related costs.
And as anyone knows, predicting the future is a nightmare.
The best way around this is to be conservative with your estimate.
If you are single and only visit the doctor and dentist for routine checkups, then you might only want to put aside enough money to cover the cost of these visits.
If you know you have a cavity that you’ve put off getting filled or know you need X-rays, then you can bump up the amount you are saving.
The goal is to get as close to the actual amount you spend as possible.
Then if you still have $100 in your account, you can make a trip to your local pharmacy and stock up on items that are covered.
#3. Limit To What You Can Use Money For
With a flexible spending account, you can’t spend the money on just anything.
There are certain qualified expenses that are covered.
While many of the items you buy will be covered, like over the counter medicine, nasal spray, doctor visits, and prescription medications, others are not.
This included things like diapers, soap and body wash, toothbrushes, etc.
It is important you get a list of qualified expenses from your healthcare plan provider so you know you will be reimbursed for the items you plan to purchase.
#4. Could Lose Child Tax Credit
The child tax credit and a Dependent Care FSA both are ways to defray the cost of childcare.
But you cannot use both.
You have to decide which option makes more sense for your financial situation and go with that plan.
For example, if you have a Dependent Care FSA and use it to cover $10,000 worth of qualified expenses, you cannot use the child tax credit for these same expenses.
Because of this, it is important to talk to your tax accountant so you pick the option that will offer you the largest tax break.
#5. Lose Money If You Lose Your Job
Arguably one of the biggest drawbacks to flexible spending accounts is what happens to your money if you lose your job.
If you contribute to an FSA and end up quitting or getting fired, you lose the money you contribute.
So if you put $1,000 into your account and lose your job, you lost that money.
Because of this, it is important you take into account your job situation.
Is your job secure? Are you looking to retire or look for a job at another company?
The good news is if you plan to quit or retire, you have time to spend the money in your account.
And as one of the pros mentioned earlier, you can spend all the money you contribute even if it all hasn’t been allocated into your account yet.
At the end of the day, there are many pros and cons of flexible spending accounts.
If you take the time to come up with a conservative estimate for your annual healthcare needs, using an FSA can be a smart way to pay for these expenses.
But it is important to understand the risks first.
If you think your job is in jeopardy, you might be better off saving money for healthcare costs in a separate savings account that you manage.
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I have over 15 years experience in the financial services industry and 20 years investing in the stock market. I have both my undergrad and graduate degrees in Finance, and am FINRA Series 65 licensed and have a Certificate in Financial Planning.
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