Understanding Flexible Spending Accounts

Pretax benefit can really add up, plan administrator says.

By Richard Chin, Contributing Writer

Use it or lose it.

Those five words stop a lot of people from saving money on their health care spending through something called a flexible spending account, a tax break created by federal law that allows you to use pretax dollars deducted from your paycheck to pay for dental and medical expenses not covered by insurance.

The savings can amount to a discount of as much as to 25 to 40 percent, depending on your income tax rate, for out-of-pocket medical expenses on everything from eyeglasses to braces to doctor visits and prescription co-pays.

But to take advantage of the program, you have to estimate how much in non-insured medical expenses you’ll incur in the next year to determine how much to set aside from your paycheck. You forfeit the money you don’t spend by year’s end. In other words, use it or lose it.

It’s that provision that scares off a lot of people from setting up an FSA, according Jody Dietel, chief compliance officer with WageWorks, a San Mateo, Calif., company that administers FSA plans.

But according to Dietel, it can still be worthwhile to participate in an FSA even if you might leave some money on the table.

To set up a flexible spending account, do you have to be employed at a workplace that offers FSA plans?

Right. An overwhelming number of larger employers, those with 200 or more employees, generally have a health flexible spending account on their menu. And then for a growing number of smaller employers, a health FSA is on their menu as a benefit.

What stops people from setting aside money in a flexible spending account?

The number one reason we see when we survey people who don’t participate is, “I’m afraid of use it or lose it. I’m afraid I’ll lose money.” Number two is they have a tough time predicting their expenses. A tip is: test the waters. Go through your checkbook and your credit card statements to see what you did pay for out of pocket expenses. If you find that for the last year you spent $1,000 and you’re still chicken, why don’t you try $500. Generally what we find is people have used that money by April and are begging for more and they have to wait until the next plan year.

Why does the use it or lose it provision exist?

The use it or lose it provision was inserted by the IRS and Treasury Department. They did it because they were concerned that employees might defer large amounts of income through these accounts.

The IRS was worried that people would use FSAs as a tax shelter?

Yes. It’s not in the original statute and over the course of time there’s been repeated cries for its removal. Many people believe with a $2,500 limit on how much you can set aside for FSAs which start January 2013 (under a provision of the 2010 Affordable Care Act), there’s no more need for use it or lose it. There’s a number of bills in Congress currently that have wide bipartisan support that would eliminate use it or lose it and allow employers to cash out on a taxable basis unused amounts.

How likely am I to lose by putting money into a flexible spending account?

If you’ve set aside $2,000, and you’re in a 25 percent marginal tax bracket, you’ve saved $500 on that money. So until you’ve lost $500 or more, you’re still money ahead. In most cases, employees don’t lose money. We tell people to plan carefully. We generally encourage people to go through their checkbook, their employee benefit plan, their dental, vision, medical carriers and see what kind of out-of-pocket expenses they’ve had. Many people do have predictable out-of-pocket expenses so it’s very unusual for people to lose money. And when they do lose money, it’s generally less than $85. People don’t really lose money. It’s a fear more than anything else. Secondly when they do lose money, the money reverts to the employer and it’s really used to pay for the administration of the plan.

And even if I haven’t used up all my FSA money by year’s end, there can be a grace period to spend that money?

The grace period came about in 2005. U.S. Sen. Chuck Grassley of Iowa said, “We want you to revisit this use it or lose it rule. It doesn’t make any sense.” And the grace period was kind of their answer to that. They didn’t go so far as to eliminate the use it or lose it rule, but they added this grace period in which you can use current plan year expenses against last year’s limit to use it up. It’s actually up to the employer to set it up as a plan design rule. It’s up to a maximum of two and a half months. And generally when employers put it in, and the vast majority of employers put it in, they do allow the full two and a half months, or until March 15 to incur expenses.

I used to be able to buy aspirin, cough syrup and other over-the-counter drugs with FSA money. Now that’s harder to do?

It’s not that they’re not covered. It’s just that they’re not covered unless they’re prescribed. Many people go to the doctor, and the doctor says ‘I want you to take a baby aspirin every day.’ If he tells you to do that, have him write it on a scrip and it’s still covered. There’s still about 35,000 over-the-counter products that are eligible: bandages, gauze pads, ThermaCare back wraps, contact lens supplies, denture adhesives, reading glasses, condoms.

Note: Ms. Dietel’s comments in this article are hers alone and do not represent those of UnitedHealth Group, its officers, directors, subsidiaries or affiliates.