Most insurance plans require you to cover certain medical costs, such as co-pays and deductibles. Does your income take care of all of these expenses? To be even more specific, can your pre-tax earnings pay for them? If so, you should consider a flexible spending account (FSA). In this article, we will answer two key questions. Firstly, what are FSA funds? Secondly, what happens to unused FSA funds at the end of the year? Keep in mind that the best way to take advantage of an FSA is through careful planning.
While account holders enjoy certain tax benefits, FSAs also have deposit rules and limitations. Yet this shouldn’t discourage consumers from utilizing an FSA if their employers offer it. For a start, this account type is an alternative to an HSA, especially when you aren’t eligible for the latter. Above all else, when your finances are organized and well-tracked, FSAs will allow your taxes and medical bills to follow suit.
What Are FSA Funds?
When your employer pays you, they deduct taxes from your wages. However, you may also set pre-tax money aside to take care of medical expenses. Once per year, after you make an estimate of these costs and submit them, your employer will set aside the funds in an FSA. During the upcoming year, this amount will pay for medical and health care bills.
The open enrollment period is usually in November and December. Employers must hand-in a deposit request if they want to open or continue to use an FSA, starting on January first. Those who fail to enroll must wait until next year’s open enrollment period, unless they qualify for an exception. More specifically, those who go through a life changing event, such as a job change or marriage, may enroll in an FSA outside of the regular timeframe.
Each person may contribute up to $2,700 per year into an FSA. In other words, a spousal account has a maximum annual deposit of $5,400. A child’s FSA, meanwhile, has a $5,000 yearly contribution limit. To access the money, account holders can request a check or wire transfer from their employer. Additionally, some FSAs allow you to use a debit card.
What Are FSA Funds’ Tax Status?
Firstly, your employer doesn’t deduct any taxes from FSA deposits. In general, the IRS considers medical expenses as tax deductions. That is to say, the portion of your income that went towards health care costs is not taxable. Employees can only make FSA contributions once annually, which is during the open enrollment period.
After that, they must spend the money by the end of December of each year. This is important because recipients don’t control what happens to unused FSA funds. Therefore, you should carefully estimate what your medical needs will be before requesting the deposit. Otherwise, you could lose a portion of your FSA balance.
What Happens to Unused FSA Funds?
By December 31st, employees should have used all of their FSA money. However, you are allowed to roll-over $500 to the next year. If you have more than that, FSA rules give you a two and a half months grace period. To clarify, here is an example: An employee deposited $2,400 during the 2019 open enrollment timeframe. In turn, they can spend the $2,400 on eligible medical expenses between January and December of 2020.
By the end of the year, the consumer only used $1,500, and their remaining balance was $900. Firstly, under the FSA exceptions, $500 of that amount rolls over to the account holder’s 2021 budget. Secondly, the grace period gives the consumer until mid-March of 2021 to spend rest of the money ($400). If they don’t, the balance is forfeited and the employer (not the employee) determines what happens to unused FSA funds.
In general, companies follow several approaches when they address expired FSA balances. On one hand, they may return it to the original depositor in increments. Yet the employer could also keep the money. Alternatively, some of them choose to distribute the expired amount amongst other employees. This covers their FSAs and/or other benefits.
HSA vs. FSA: What Are FSA Funds’ Pros and Cons?
While both of these account types help you pay for medical expenses, there are key differences between them. The main ones include the following:
- Deposits and withdrawals from FSAs and HSAs are tax-free. This is because all medical expenses are deductible. Yet if your employer doesn’t offer an HSA, you may have to deposit after-tax funds and claim the deductions when you file.
- You can deposit more money into an HSA, up to $3,500 per person or $7,000 per married couple. A senior account holder can contribute another $1,000 (in addition to the deposit maximums). FSAs, on the other hand, don’t give elderly consumers this exception.
- Some employers provide workers with HSA benefits, but even if they don’t, employees could open a personal/private HSA. You can only enroll in an FSA if your workplace offers it.
- HSA balances, unlike FSAs, don’t expire. In other words, you don’t lose any unused HSA funds in December or after a certain amount of time goes by.
- You could invest your HSA deposits in stocks, commodities, and other financial instruments. FSAs typically don’t have this feature. Moreover, your HSA investment profits are tax-free.
Why Not an HSA?
In comparison to FSAs, HSA funds have two key advantages. Firstly, you could grow your HSA balance by investing the money. Secondly, unlike FSAs, account holders don’t need to spend their HSA amount by the end of the year. However, that doesn’t mean that an HSA is always a better choice.
Not everyone has the time or knowledge to invest in the markets. In fact, doing so without adequate preparation could cause you to lose money. Equally as important, only people who have a certain annual insurance deductible are eligible for an HSA.
You can easily avoid what happens to unused FSA funds by simply planning ahead. That is to say, employees may deposit a relatively smaller amount to stay safe, even if it doesn’t cover all of the medical expenses. In turn, they can pay for any additional costs through a medical credit card. Similarly, you could use both an FSA and HSA at the same time.
Nonetheless, FSAs are a great way to pay for medications, dentist visits, and other health care necessities in pre-tax income. What are FSA funds? In short, they’re your medical costs for the next 12 months, but they also form a sizable portion of your paycheck. You can either use it or lose it. Better yet, you could carefully calculate it and use it. Period.