A flexible spending account, also called an FSA, is a good way to put aside money to pay for healthcare or daycare expenses. With an FSA, you are saving money because you don’t pay taxes on the money you put aside. However, there are limits on the tax savings, and you must use the money within the time period allotted or you lose it.
Many companies allow you to put aside money in an FSA. The government limits your contributions to a dependent care FSA to $5,000 annually, and starting in 2013, contributions to a healthcare FSA will be limited to $2,500 annually per person. One unique feature of the accounts is that you can pre-spend the money, meaning you can be reimbursed for expenses that exceed your year-to-date contributions, as long as the amounts do not exceed the maximum amount you are contributing for the calendar year.
You can use the money in these accounts to pay for most daycare and healthcare expenses, and many plans give you an additional three months after the end of the calendar year to seek reimbursement.
By putting the money in FSAs, you are saving money on taxes. Your contributions are tax-free, and as long as you use the money for an approved expense, you never pay any taxes on it. For example, if you set aside $5,000 in a dependent-care FSA and are in the 25 percent tax bracket, you save $1,250 in taxes.
While saving money is a good reason to utilize an FSA, there is a big drawback that you should keep in mind. An FSA is a use-it-or-lose-it type of account. That means you forfeit any money you don’t spend each year. If you put $2,500 in a healthcare FSA and only have $2,200 in qualified healthcare expenses, you will forfeit the $300.
This makes it extremely important to estimate and budget accurately. This can be hard to do with healthcare expenses, although it is easier with daycare expenses, because you can usually estimate how much you are going to spend for child care.
