Kyle runs Suburban Dollar and has a passion for finance, saving, and debt reduction. He has a no true background in accounting, finance, or economics which allows him to bring an ordinary perspective to the world of finance. As he says on his blog it is where finance and reality meet. If you like what you have read here please subscribe to his blog for future free updates from Suburban Dollar.
Flexible Spending Accounts are tax advantaged accounts which are offered by some employers in the U.S. These accounts take pretax dollars and set them aside for a very specific use throughout the year. What you can use the money for is limited based on the type of plan and their requirements. The main advantage of a flexible spending account is that the funds are excluded from income tax. There are two main types of flexible spending accounts, the Healtcare Spending Account (HSA) and the Dependent Care Spending Accoutn (DSA).
Healthcare Spending Accounts
These accounts are intended to pay for qualified medical expenses not otherwise covered by your health insurance plan. Types of allowable expenses are copays, deductibles, dental expenses, vision expenses, over the counter medication, and most other purchases related to treating a medical condition. There is no federal limit on how much money can be put aside in an HSA, however, most employers cap your contribution amounts to prevent liability
HSA accounts can even be used to pay for surgeries like Lasik but can’t be used for cosmetic surgery. Sorry, no tax free boob jobs. You can actually spend the amount of money you have allocated for HSA’s before you have funded the account. If I decided I want to put $2k in next year, I can spend $2k on January 10th out of that account. I won’t be able to use the account for the rest of the year, but at that time it still hasn’t been deducted from my payroll.
Dependent Care Spending Accounts
Dependent care accounts are intended to cover expenses related to caring for qualified dependents while you are at work. These accounts have a maximum limit of $5,000 per year. It doesn’t matter how many children you have in daycare, you only get the $5,000. Unlike their healthcare counterparts you can only get out what you have already put in. No advances.
Another thing to keep in mind is the plan is only valid if both spouses work, if only one spouse has a paying job you could be utilizing the account all year only to find out it is all taxable income. If both spouses are working but one spouse earned less than $5,000 you can only claim up to the amount that spouse earned.
Advantages of Flexible Spending Accounts
The main advantage is the funds are being taken out of your income pre-tax. Effectively reducing your overall taxable income. Think of it like your 401k payments that come out of your paycheck.
In addition to the tax implications the healthcare spending accounts are “prefunded” accounts. If you have a major surgery or operation, like lasik, at the beginning of the year you could pay for it out of your HSA before you ever pay anything into it.
Flexible Spending Debit cards are relatively new on the scene but are a growing trend. They allow you make direct purchases using your HSA. If you are Walgreens and need some Acetaminophen pick up and pay with your HSA card. No need to worry about receipts and reimbursements.
The biggest advantage we have found to our dependent care account is the fact that we have to pay first. The money we are paying for daycare is already spent so we don’t miss it. Instead of having our reimbursements go back into our checking account we funnel them straight into savings. This gives us an additional $5,000 a year in automatic savings, and we don’t even miss from our bank account.
The One Major Downside
Flexible spending accounts operate on the use it or lose it mantra. You need to be very careful about how much money you plan to put into each of these accounts. If you choose to put in $5,000 but end up only spending $4,000 in qualifying expenses you are going to be out the rest of the money. This goes for both the dependent and health accounts.
The health accounts have gotten easier to blow through now that they allow over the counter medications and things like band aids to be qualifying expenses. Dependent care has never been a problem for us to fully use up. I would love to find a daycare that costs me less than $5,000 per year. Now with two kids going to daycare we are really feeling it every week but we still only get $5,000 which kind of stinks if you ask me.