Understanding Flexible Savings Accounts or FSAs
What are FSAs?
In March 2019, 14 percent of private industry workers had access, and 37 percent of state and local government had access to Flexible Savings Accounts (FSA).1 Within the education and health care industry, 35 percent of workers in junior colleges, colleges, and universities had access to FSAs, 37 percent of elementary and secondary school workers, and 39 percent of hospital industry workers. The access to this important employee benefit is substantial, but most employees don't understand much about FSAs.
These flexible benefits are called Flexible Savings Account or FSA is commonly used in corporate and educational settings, and allows the employee to take advantage of specific tax advantages. The FSA allows the employee to contribute a portion of their earnings before taxes to an employee account. FSA’s come in two varieties for your healthcare reimbursement and dependent care under the age of 13.
What are the Advantages of FSAs?
The major tax benefits are the FSAs allow employees to deduct the amount contributed from their earnings if used for qualified expenses from income tax and payroll tax. For someone in the 22% marginal tax bracket, this can be substantial, with at least $220 in savings on your taxes paid! Thus, the higher the tax bracket the employee is in, the greater the potential tax savings.
Employees can choose to contribute to an FSA and decide the amount up to the IRS limits. For instance, in 2021, a corporate employee can contribute up to $2,750 (per employer if a married couple) to a health FSA and up to $10,500 ($5,250 for married individuals filing separately) for a dependent care FSA.2
What are the Disadvantages of FSAs?
The major disadvantage of FSAs is keeping track of your expenses to get reimbursed. With most plans offering debit cards, you still need to keep good records because of occasional audits. Also, you must know the list of qualifying medical expenses covered by FSAs. For some, the paperwork can be a lot of work but could represent substantial tax savings.
Another disadvantage is that the employer is allowed only two options for the money left over in the account at the end of the plan year. One option is the two and a half month grace period to spend the remaining money in the account, or the plan can roll over $550 to the next plan year of unused funds for health FSAs only.
The catch is that employers can only offer one of these options, not both. As a result, the employee must craft a good budget not to have too much money left over after the plan year, as the money could be lost.
What’s My Take?
FSAs are a great way to pay for medical expenses such as copays, coinsurance, and other out-of-pocket costs. For a young couple with a child in daycare, this is a substantial amount of tax savings. The drawback is to carefully budget and makes sure that you have enough money to meet your medical and dependent care needs and not go under budget as the money will be lost.
FSAs nowadays are commonly provided, especially in large corporate employers and government. Employees should take advantage of these plans, especially in higher tax brackets, as they represent substantial tax savings.
Be sure to talk to a financial planner to help you budget and choose the right plan for your particular circumstances.
*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on to avoid any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets.