The Pluses and Pitfalls of Flexible Spending Accounts
Healthcare flexible spending accounts are an employee benefit by which workers can set aside a certain amount of their salary, pre-tax, to use for healthcare costs. Some 33 million American workers currently take advantage of FSAs to save on their income tax bills.
Contributions an employee makes to an FSA are deducted from the employee’s salary before federal, state or social security taxes are calculated. By using an FSA, you decrease your taxable income and increase your spendable income.
What FSAs Cover
Money in an FSA account can be used to cover medically necessary healthcare expenses that are not covered by traditional health insurance, like co-pays and deductibles for doctor’s visits, hospital stays and dental treatments.
FSA accounts can also be used to cover healthcare services like orthodontia, fertility treatments, birth control, acupuncture, chiropractic, medically necessary massage, and holistic and alternative doctors. They can be used for medically necessary supplies, like eyeglasses or lactation supplies.
Items used for preventative care, like gym memberships or nutritional supplements, or for cosmetic purposes, like face-lifts or hair implants, are generally not reimbursable. To be reimbursable, expenses must be medically necessary.
Until a few years ago, FSAs could be used to pay for non-prescription medicines, but this is now prohibited for all over-the-counter drugs other than insulin. Coverage for non-prescription items requires a letter of medical necessity or a note on a prescription pad from a doctor.
How FSAs Work
At the beginning of the plan year, which is usually Jan. 1, employers ask employees how much money they want to contribute for the year. The amount designated for the year is taken out of the employee’s paycheck in equal installments each pay period and put into a special account.
The entire amount can be used the first day of the year, even before it has been taken out of an employee’s salary.
The opportunity to enroll comes just once a year, unless an employee experiences a qualified “family status change” such as marriage, birth, divorce or loss of a spouse’s insurance coverage. The money from an FSA can be used for any family member, including eligible dependents.
As employees accrue medical expenses that are not covered by insurance, they submit an invoice and proof of payment to the plan administrator, who then issues a reimbursement check. Alternatively, some plans issue debit cards.
Use It or Lose It
The biggest drawback to an FSA is the “use it or lose it” rule, which was added in 1984 to prevent users from deferring excessive amounts of compensation. Any money left in the account at the end of the plan year is forfeited. Some employers allow a grace period of two months and 15 days.
About 40 percent of FSA participants forfeit at least some of their money. About 20 percent of them forfeit $500 or more. The “use it or lose it” aspect of FSAs causes many employees to engage in a year-end rush to see their doctors or buy new glasses.
Changes to FSAs in 2013
Previously, there was no statutory limit on the amount of money that could be put into an FSA account, although most employers limited it to $2,000 to $5,000. As a result of the Patient Protection and Affordable Care Act, contributions will be limited to $2,500 per person, or $5,000 per couple, in 2013.
Now that the amount has been capped, the U.S. Treasury Department is actively considering changes to the “use it or lose it” rule.