Reduce Daycare & Medical Bills
By: Gary Foreman
Dear Dollar Stretcher,
Why do people advocate Flexible Spending Accounts? Unless you are sure you will use the total amount in one year it is not a good idea. With flexible spending accounts you lose the money you don't use at the end of the year. I have never understood this since it is the employee's money. But apparently you save all year and if you don't spend it the company takes the remainder. Can you address this issue? I am very confused and imagine others are too.
Johanna's right about the possibility of losing your money. But she may be passing up a golden opportunity to reduce her daycare and medical bills. A little effort could save her $1,500 or so each year.
First, let's explain how Flexible Spending Accounts (FSAs) work. The simplest way to think of it is as a savings account. Your employer sets up the plan. Once a year you are allowed to enroll. There are two types. One is for child care expenses and the other is for uninsured medical expenses. You can enroll in either or both plans.
You tell your employer how much you expect to spend for the next 12 months. With each paycheck they'll transfer a proportionate share to your FSA. When you incur an expense that's covered you submit a receipt to your employer. They'll issue you a reimbursement check from the account.
That's how it works. But why would you want to go through all that? Simply because the money that you contribute to an FSA is excluded from your federal income tax. So you'll be paying the bills with pre-tax dollars. It's like getting a discount that's equal to your tax rate. And with today's tax rates that's a big advantage for many families.
The plans are especially helpful for middle income wage earners. Many do better with an FSA than they would with the 'child care credit'. Also families that don't have enough medical bills to allow them to itemize medical expenses can benefit.
The law says that you can't contribute more than $5,000 to a dependent care FSA. There is no legal limit on medical care FSAs, but most employers cap contributions at $3,000 or less. You'll have a limited time for enrollment. So when your employer gives you the application don't let it sit around.
Johanna has pointed up the biggest danger of FSAs. Once you set the amount that you'll contribute to the account, you can't change it unless there's a "significant family event". But don't let that scare you. That should be all the escape that you need.
For instance, suppose you have a child in daycare and contribute the expected cost to your FSA account. Unless you or your spouse lose your jobs or become disabled, you're very likely to continue using childcare. And if you did lose your job or become disabled it would be considered a significant event and you'd be allowed to stop the contributions.
On the medical front many expenses are routine and predictable. How many dental checkups will your family have this year? If you know how much you pay for each exam you'll know your minimum dental bill for the year. The same thing holds true for routine physicals and eye care.
You can also use the FSA to pay for co-pays and deductibles. With a little thought you should be able to predict a minimum amount that you'll spend on medical care. That's the amount that you should contribute to the FSA.
Let's look at an example. Suppose that Johanna's family pays 20% in Federal income tax. If they spend $5,000 on childcare they'd need to earn $6,000 to cover that bill. If she uses the FSA she'll save $1,000 in income taxes. That's like getting a 20% discount on your daycare bill!
Could she lose her contribution to the FSA? Yes, it's possible. But if she only contributes the minimum expected expenses it's unlikely. Predicting eye and dental exams isn't rocket science. And unless you stop working, daycare expenses keep on coming. If you lose your job you can stop the contributions.
What happens if she only used $4,500 of the $5,000 that she contributed for childcare? Yes, she'd lose the extra $500 at the end of the year. But she would have saved 20% of the $4,500 she spent in reduced taxes. That's $900. So Johanna is still $400 ahead.
If your employer offers a Flexible Spending Account take a good look at it. By contributing an amount equal to your minimum expected expenses you could save $100 or more each month.
Gary Foreman is a former Certified Financial Planner who currently edits The Dollar Stretcher website www.stretcher.com You'll find hundreds of free articles to help you save time and money.