While there are many pros of flexible spending accounts that help you with medical and allied expenses, there are also inevitable cons which may not prove to be financially beneficial. This HealthHearty article will tell you about the advantages and disadvantages of opting for these accounts.
Thoroughly analyze if you are actually going to benefit from the flexible spending accounts. If you find that you cannot save much through this method, do not opt for it.
A flexible spending account (FSA) is a tax-advantage financial account that can be set up by an employer via the cafeteria plan. An employee needs to contribute a part of his earnings for medical and other allied expenses. The interesting aspect about this contribution is that it is exempted from income tax, payroll tax, state tax, and local tax. The two types of FSA are health care and dependent care. One has to submit proofs of expenses in the form of receipts in order to get the reimbursement of the amount. There are several benefits of availing these accounts. However, like its pros, FSAs also come with their share of cons. For example, you will have to utilize the entire amount within a plan year.
They are Tax-free
One of the most important features of FSAs is that they are tax-free. They are special employee-funded accounts which help to use pre-tax earnings for reimbursement of approved medical and dependent care expenses. They also help in covering expenditures, like co-pays, dental and vision care, medical services, prescriptions, and over-the-counter medications. Daycare expenses are also reimbursed through this account. This way, you avoid paying for these out-of-pocket expenditures with money that is already taxed by getting an reimbursement through your pre-taxable earnings.
Contingency for Health Care Expenses
Many times, we do not save money for sudden medical expenses for ourselves or our family members. At times, there can be an unexpected medical emergency in the family. At such a time, a huge hospital bill and medicine-related expenses can erode a significant chunk from your income. However, if you have deposited some money every month in your FSA, it will act as a contingency for health care expenses. You will keep aside money for this purpose every month, and it will get accumulated over a period of time.
Allows Debit Card Usage
According to recent developments, one may also get a special type of FSA debit card which allows the purchase of ‘FSA-eligible’ items. This card can only be used at medical providers or hospitals, true pharmacies, grocers, discounters, and online pharmacies. Retailers with an inventory information approval system (IIAS) can separate eligible items from the other purchases. They can auto-substantiate the eligible expenses at the point of sale. Then you can pay for these items through your FSA debit card, and pay for the rest through your other regular debit/credit cards or cash.
Excellent for Employers
As FSA is tax-free, employers use the savings on payroll taxes to cover the cost of administration, and even earn interest on the account balances. Not only this, but they can also forfeit the balance of an employee who decides to leave them before the end of the year without utilizing the entire amount which he has contributed. An employee has the option of continuing to contribute towards the amount through Consolidated Omnibus Budget Reconciliation Act (COBRA). Some companies also limit the amount that the employees contribute towards their FSA to avoid paying for those who demand early reimbursement and leave. However, this is profitable for the company as the contribution is deducted before the income and payroll taxes are levied. Thus, the company as well as its employees save a lot of money on payroll and income taxes because of this account.
Excellent for Employees
An employer sponsors the FSA account of an employee. He has to reimburse the full amount of eligible expenses that an employee has selected, even if he does not work for one whole year and has not contributed the entire amount. For example, You decide your contribution to be ‘X’ amount for the FSA. However, you can file a claim for the entire ‘X’ amount in the very second month even if you have contributed only some amount towards it. The employer will have to reimburse the entire ‘X’ amount to you. Even if you leave the job after being reimbursed for the full amount, you are not obligated to pay it back to the employer. It helps employees to save money on health care expenses, especially if the organization does not offer health insurance.
‘Use It or Lose It’ Rule
This is perhaps the biggest drawback of FSA. If you are a person who has low annual expenses, then having this account is not advisable. This is because you cannot roll over the money of one year into another. That means, if you could not use up the $2,000 in your FSA account by the end of the calendar year, you will have to forget about it. There are many companies which cut the spending on 31st December exactly at the midnight, while there are a few others who utilize the 2.5-month grace period allotted by the IRS. Hence, if you fail to use the money which is a part of your income before the end of the year, you will stand to lose it.
Not Advisable for Child Care
The IRS offers a percentage of kickback on the child care expenses you incurred during a year. The FSA also offers some child care coverage, which many parents opt for. They prefer going for an FSA which is tax-sheltered, rather than the child care expenses which are applicable on post-tax dollars. Many people are not aware of the fact that if you use this tax-sheltered option, you may lose out on child care credit at the time of the annual tax return. You cannot claim the same child care expenses for both the options. If you are a family which falls in the low income bracket with a low AGI, it is advisable that you utilize the child care tax credit option, instead of getting a reimbursement from your FSA. If your earning is low, you may not benefit from this account as a lesser amount will be contributed towards their flexible accounts. On the other hand, getting a federal tax benefit for child care expenses will bail you out.
Maintaining All Records and Receipts is Mandatory
You will have to pay for the FSA-eligible expenses, fill the necessary forms, and give receipts as proofs. If you do not fulfill all these requirements, you may not get reimbursement for the payment which you have made. These days, many employers issue a debit card to employees for their FSA transactions. Also, it is mandatory to maintain itemized receipts for the purchases charged to the FSA debit card. It can become extremely tedious and cumbersome to maintain a record of all the receipts. Hence, it is important that you are aware about the type of expense and maintain all the records pertaining to it properly.
Limitations to Dependent Care
There are many restrictions which are imposed on the dependent care FSA. It cannot be more than $5,000 for a single household. Any amount that exceeds the $5,000 mark will be eligible for taxation. Both the married partners must contribute towards this option; however, the total should not exceed $5,000. Only if the non-earning spouse is disabled, or is studying full-time, the other earning partner can contribute on his own. Also, one cannot receive reimbursement of full amount like the medical FSA. In fact, you will be getting the amount that you have deducted during that particular year.
If you are not offered too many benefits by your organization, then opting for this facility can prove advantageous as you will get a reimbursement for medical and other expenses. However, a low-capped FSA will not provide much benefit of the pre-tax savings. Also, it will take away a lot of your precious time to complete the formalities for the reimbursement. Now that you know about the pros and cons, invest your money wisely to derive maximum benefits from them.