There are several reasons to take advantage of an FSA if your employer offers it. In addition to the tax savings mentioned above, most FSAs are also prefunded. That means if you pledge $2,000 to the account for the year, it's available to you immediately if an emergency arises. Many users also find that an FSA is an easy and effective way to budget for medical expenses throughout the year, especially if you suffer from a chronic condition and need supplies or doctor's visits on a monthly basis.
Perhaps one of the most convincing reasons to take advantage of an FSA is that it could actually increase your amount of take-home pay. This is because the money added to the FSA is not subject to payroll taxes, which could then lower your tax bracket and lower your annual income tax payments. If your taxable income is lowered, your weekly take-home pay can go up.
This argument may make you want to run out and contribute as much as you can to your FSA, but beware -- you can get burned. A major con to an FSA is the "use it or lose it" rule. All unused money in your FSA at the end of the plan year is given to your employer. So it's really important to be conservative when figuring your yearly FSA pledge and to try and match it as precisely as you can to your actual medical expenses. If not, you could lose a lot of your own money, and you might even end up owing taxes on all that money you didn't spend. A slightly less immediate, though no less serious, consequence of this reduction in taxable earnings is that it can reduce your Social Security benefits during retirement.
Next, we'll get the details on the other kinds of FSAs.
Types of Flexible Spending Accounts
There are a few types of FSAs available, though two are more prevalent than the others. Medical is the most popular. With innovations like the Flexcard and prefunding becoming more widely available, this kind of FSA is getting easier to use and gaining a much broader popularity with both employers and employees.
A second kind of FSA reserves money for the care of dependents. Many people use them for child care expenses, but it can also fund the daily care of dependent adults. Usually, dependent-care FSAs are more complicated than medical accounts because the costs of substantiation are much higher. Dependent-care FSAs are not prefunded -- costs are reimbursed only after careful scrutiny of the appropriate documents. These accounts are also losing popularity thanks to changes in tax codes that make tax credits more attractive than the pretax deductions found in the dependent-care FSAs.
In recent years, companies have also been providing a separate FSA for adoption services, though these aren't as popular as the medical and dependent-care FSAs.
To learn more about flexible savings accounts, check out the links on the next page.