The Investment Scientist

The pros and cons of Flexible Spending Accounts

Posted on: September 28, 2012

FSA: It’s all about flexibility

Flexible Spending Accounts (FSAs) are benefits offered by some employers. Money put in the accounts is exempted from income tax, payroll tax, and in most cases state and local taxes.

There are generally two types of FSA: health care FSA and dependent care FSA. As the names imply, money in a health (dependent) care FSA can only be used towards eligible health (dependent) care expenses.

Take my wife as an example; she put $2,000 into her health FSA and another $5,000 into her dependent care FSA. Since we are in the highest tax bracket and we live in a high tax state, the total tax saving is close to $3,500, or 50%.

One nice thing about FSAs is that many health and dependent care expenses are eligible.

We spent about $10,000 for my son’s Montessori school. That already used up the $5,000 of our dependent care dollars.

The following health care expenses were eligible for our health care FSA money:

  1. My eye exam and a new pair of glasses.
  2. My whole family’s bi-annual dental cleaning and related dental treatments.
  3. All copays from our doctor visits.
  4. My wife’s massages – she has back pain, so those are covered.
  5. My wife’s counselling sessions.
  6. My gym membership and physical trainer – OK, I actually did not claim those, but if I could get a doctor to say that I need exercise to stay healthy, those expenses would be covered as well.

So you see, there are a lot of expenses that fall into the eligible category. You can google “FSA jukebox” to see the full list.

Now what are the cons of FSAs?

The biggest con is the “use it or lose it” rule. In other word, if you put $5,000 into your FSA and you only claim $1,500, the other $3,500 is lost.

The second biggest con is the burden of record-keeping. You have to be constantly mindful of which expenses are eligible, get receipts, and then remember to file claims. Many of the expenses such as sunscreen lotion and doctor visit copays are $5, $10, $20 in nature. The money adds up, but so do the record-keeping hassles.

So my advice to those considering putting money into FSAs is only do so if:

  1. You have one or two big expense items that are eligible for FSA money, or
  2. You are extremely meticulous.

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.


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