Both Medical Flexible Spending Accounts and Dependent Care Accounts are funded by pre-tax deductions from your paycheck. Both have a “use or lose” policy if the funds deducted are not used in the calendar year for which the election is made.
Generally, an individual can only elect to have these deductions taken at the time of hire or during the annual enrollment period each company offers its employees to make changes to their health and welfare benefits. (There are also other times during certain “life events,” such as marriage or the birth of a child, when benefit elections may also be changed.)
Since the election to make these deductions is made for a full year, one must be very cautious with the amount chosen. If you do not use the funds for eligible expenses in the allowed time period, you will not be able to get the money back.
For those with young children or older parents who need day care, the Dependent Care FSA may be helpful. The maximum amount that can be set aside is set at $5,000 each year. Since child and adult care costs are what they are, it’s not likely that an employee will end up not using the full amount set aside, so it makes sense to maximize it.
However, the dependent care program only allows a person to receive funds that are already in their FSA account, regardless of how much the person has already paid in dependent care expenses. For example, if a person chooses the maximum of $5,000 to withdraw over the course of the year, after 3 months there is only $1,250 in the account. Even if the person has already paid more than that to the child care provider, they can only receive the balance.
However, with the medical flexible spending account, a person can be repaid at any time during the year up to the annual amount chosen to be withdrawn. Therefore, the person can receive funds from the FSA before the funds have been withdrawn from their paycheck.
Let’s say you know you’ll have a surgical procedure in January and it will cost about $5,000, so you choose to have $5,000 deducted from your Medical FSA during the open enrollment period. In February, you pay your share of $5,000. Even though you only have about $800 or more in your FSA account, you can file a claim for reimbursement for the full $5,000 you paid.
It’s prudent to review what your projected medical expenses may be for the coming year, verify they are FSA-eligible expenses with your employer’s FSA administrator, and then make your choice. It doesn’t hurt to underestimate, so you may have to pay some expenses with after-tax dollars, but that’s a lot better than giving money away because you overestimated and lose what you had deducted and didn’t use.
Some examples of using a medical FSA are when you incur expenses for orthodontia and dental procedures for which you have a high deductible and/or copay. Regular doctor office visit copays, which are generally not exceptionally expensive, are eligible for reimbursement from the FSA. If you go often enough, even saving a few tax dollars can be beneficial.
Using the FSA is a great tool for enforcing a disciplined savings schedule to cover expenses that are expected to be incurred anyway during the year. And by doing it through a tax-deferred program at work, you’re ultimately lowering the cost by your marginal income tax rate so your savings are extended to buy more services from you. (Someone in the 20% marginal tax bracket, for example, would have to earn $1.25 to have enough cash to pay for $1.00 of services after the tax impact.)
By taking time to project your personal expenses, you may ultimately benefit from Uncle Sam’s help.
