My sister asked me the other day if she should set up a Flexible Spending Account (FSA). Of course, my answer was yes! You’re able to set aside money for healthcare or childcare/dependent expenses on a pre-tax basis when you create an FSA. In her case, she was asking this question because she is in the re-enrollment period for her company-sponsored health insurance. Many of us are in the same boat, that have healthcare plans that begin July 1st.
A flexible spending account is a great, tax-advantaged tool that can help you save for health and dependent care expenses. Tax-advantaged means you can automatically transfer money from your paycheck into the FSA, prior to taxes being taken out. It is a win-win. You save money on taxes and have money set aside for eligible healthcare and dependent care expenses.
Tax-advantaged or pre-tax dollars means that the money is set aside before taxes (Federal, FICA, and State) are taken out of your paycheck. Setting money aside in this way, before taxes, has two benefits: (1) Setting this money aside before taxes lowers your end-of-year tax bill. When the money is set aside, prior to taxes, it is though that money never existed. (2) Because the money is going into the FSA account before taxes are taken from it, you get a little extra – because the taxes were not deducted.
The draw-back to an FSA account is that it’s a “use it or lose it” account; you either use your money by the end of the year or forfeit it. Calculating how much you want to put into the FSA account is very important and if this is your first year using one, I suggest that you underestimate. Although, there is some flexibility as you roll into the next year, and you can reassess your needs during your open enrollment period. For more information, read the factsheet that I co-wrote on Flexible Spending Accounts.