What is an FSA?

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shutterstock_111443774At this time of year, many employers have what’s called an “open enrollment” period, during which you can change health insurance plans, and sign up for some tax-savings accounts. One of those accounts is called a “Flexible Spending Account,” or “FSA.”

An FSA is a great money-saving tool, and works like this: Your employer takes a portion of your pay (up to $2,500 per year) and puts it into a special FSA account. The money is deducted pre-tax, so you don’t have to pay income tax on the money re-directed to your FSA. When you incur certain healthcare-related expenses, you can pay for them with the money in the FSA. (Some employers give you a debit card that you can use to pay for qualifying expenses, but others make you pay and then submit the bill for reimbursement.)

The list of qualifying expenses is extensive, and includes doctor’s bills, dental bills, contact lenses, contact solution, glasses, prescription medication, and more. You can find the full list of qualifying expenses in IRS Publication 969 and Publication 502.

Here’s an example with actual numbers: Assume you are in the 25% federal income tax bracket. On $1,000 of income, that’s $250 you have to pay to the federal government. So by having your employer re-direct $1,000 of your income to your FSA, you save $250 that year! And that doesn’t take into account any state income tax savings.

Of course, there’s a catch and it’s a big one: You lose any money left in your FSA at the end of the year. (Some employers allow a grace period at the start of the following year in which you can use up what’s left in your FSA from the previous year.)

So the trick to maximizing your savings with an FSA is to predict how much you will have in qualifying expenses the following year. It’s not always easy, but taking a look at previous years’ expenses can be helpful, as can taking into account any expenses you know will be coming up. For example, I will be increasing my family’s FSA contribution when my son’s orthodontist tells me that he’s going to need braces the next year. Other possible expenses you might be able to foresee include giving birth and elective surgery.

It’s a good idea to have a plan for any money left in your FSA at the end of the year. My usual plan to is spend the money on new glasses and/or stock up on contact lens solution. Keep in mind that doctors’ offices can get very busy at the end of the year, due to vacations as well as people looking to use up that last bit of FSA money. Plan accordingly!

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Cathy is the founder of Chief Family Officer, where you can get daily updates on the hottest deals, and tips to achieve financial freedom and family bliss.