Listen to Your Heart...Maybe You'll Use an FSA
A little record keeping can mean substantial savings
Not all decisions need send you running for the nearest copy of Navigating Your Health Benefits for Dummies (yes, there is one). The flexible spending account is simple: If your employer offers one–and most large firms do–you should seriously consider using it. An FSA lets you put away pretax dollars to pay out-of-pocket medical expenses ranging from surgery to over-the-counter sinus spray. The money is pulled from your paycheck into an account from which you are reimbursed.
If you manage your FSA wisely, it can mean substantial tax savings: 23 percent, on average. The breaks are even bigger for earners in the higher brackets. Someone in the 28 percent tax bracket who puts aside the maximum of $5,000 each year, for instance, can save an estimated $1,400 in taxes.
The only tricky part is determining how much to put into the account, since with most plans what you don't use by the end of the year you lose. Witness the December bottleneck at eye doctors' and dentists' offices as patients scramble to spend down their FSAs. "The most important part of an FSA is to keep good records and plan carefully for the year ahead," says Kevin Kraushaar, vice president of government relations for the Consumer Healthcare Products Association. "Otherwise you may end up leaving money on the table."
Turnoffs. That fear, plus a lack of understanding of the tax benefits, and the hassle of keeping records and filing for reimbursement, may explain why only 20 percent of employees at big companies offering FSAs actually participated in the program last year, says Blaine Bos, a worldwide partner with Mercer Health & Benefits, which conducted an industrywide study in 2006. "Many people don't understand the tax advantages of an FSA, or they are worried about losing money at the end of the year." For fear of not recouping the money set aside, FSA participants often put less into their accounts than they should.
But their worries may be overblown. Estimating future expenses isn't as daunting as it seems, and playing it safe by underfunding an FSA will still create benefits at tax time. To start, tally up your biggest and most obvious expenses: deductibles, estimated copays for office visits and prescription drugs, eyeglasses, routine out-of-plan doctor and dental visits, or those that are only partially covered, such as psychotherapy. (Cosmetic surgery is not reimbursable.)
Then, if you are planning an uncovered procedure such as laser eye surgery, or major dental work, you can set aside funds for that. Estimating expenses for over-the-counter drug purchases, which have been reimbursable with FSA funds since 2003, can get dicier, especially the first year when you may not have receipts to gauge your previous-year expenses. As a general rule, over-the-counter products used to treat personal injuries or sickness are eligible. They include antacids, allergy medicines, pain relievers, and cold medicines. Some dietary supplements may qualify so long as they are needed for a specific medical condition, such as calcium for osteoporosis or iron for anemia.
Cosmetics and toiletries such as shaving cream and shampoo are not eligible. Neither is that bogus Botox-in-a-bottle (or the real Botox, for that matter). Also out: vitamins, minerals, and other supplements that are used mainly to promote general health rather than to treat a specific condition.
Keep on filing. It's easy to lose track of OTC purchases because they can be small and mixed in with other items, such as groceries or gasoline (Advil for that road-trip headache). "People with FSAs need to keep track of all their receipts and also file them frequently," says Kraushaar, noting that lost opportunities for OTC reimbursements are the biggest cause of forfeited FSA funds at the end of the year. Timely filing also will help you keep track of how much money you have left in your account as the year winds down.
Some pharmacies, such as CVS and Safeway, make the record keeping easier by reminding customers at the register and on receipts that certain OTC purchases are reimbursable through an FSA. Although most plans still require that the user submit receipts to be reimbursed, some have begun offering debit cards that can be used at the time of purchase (and also for copays), thereby eliminating the paperwork.
If you still find yourself scrambling to empty out your FSA as December comes to a close, check with your employer, as your plan may be one that allows expenses incurred in the first 2½ months of the new year to be charged against the previous year's FSA. Since the IRS relaxed the filing rules last year, most employers have adopted them, according to Mercer's Bos. If your plan doesn't have an extension, well, maybe it's time for a new pair of glasses.
This story appears in the December 11, 2006 print edition of U.S. News & World Report.