Almost every American is familiar with health insurance.  In return for a monthly premium, the insurance company pays for whatever medical needs arise, minus co-pays, deductibles, and excluded categories, which the consumer must bear.

Insurance is made more affordable because the employer usually bears most of the cost and the consumer's portion is not subject to payroll taxes.  But many companies also offer medical Flexible Savings Arrangements (FSAs) to make out-of-pocket expenses cheaper, which many fewer Americans are familiar with.  More than 85% of large and mid-size companies offer this option, along with the federal and many state and local governments, but fewer than 1 in 5 eligible Americans take advantage of the program.

The idea of a medical FSA is simple:  A fixed amount of money is deducted before taxes from every paycheck.  You then use this money for out-of-pocket health expenses.  At the end of the year, you lose what money remains in the Flexible Savings Arrangement account, and you start over at zero at the beginning of the next year.

There are usually two ways to access funds in a medical FSA.  Most often, you will use a debit card.  You can also fill out paperwork to get reimbursement for an expense you already paid.  There is a grace period at the end of the year that allows consumers to submit more claims to ensure the maximum credit possible.

Many out-of-pocket expenses are predictable, like replacement orthotics, glasses, regular prescriptions, and regular appointment copays.  Some other major out-of-pocket medical expenses, such as wisdom teeth removal, LASIK eye surgery, fertility treatments, braces, tonsillectomies, many hysterectomies, and often hospital birth fees can also be anticipated.  By carefully going over your records from previous years, you can also predict with reasonable certainty the likely minimum amount of money you will spend on unexpected expenses, like visits to the pediatrician with sick kids or short-term prescriptions.  Come to a total, divide by 52, and you get the dollar amount per week that you should be putting into your company's FSA plan.

A couple of warnings:  Once you set your yearly payroll deduction level, you can't change it.  Also, you must keep detailed, specific receipts for every single expense, as a number of transactions are sure to be kicked back to you with requirements that you provide proof that the purchase was eligible.

The Smiths, a family of four, have prescriptions for Nasonex and Lipitor, costing a total of $30 out-of-pocket every month.  They have four checkups every year at a co-pay of $20 each, plus Mike's yearly visit to his allergist at $40.  Johnny's braces are going to cost $2500 out-of-pocket that year.  The dentist has been warning Sally that an old crown is loose and needs to be replaced to the tune of $700, and while teeth cleanings and routine fillings are covered by their dental plan, major work such as this is not.  Suzy and Sally both need corrective lenses, and while their eye insurance covers their exams, it only pays the first $100 of Sally's contacts and $200 towards Suzy's desperately needed new glasses, which won't cover feather-light lenses with a scratch-resistant coating and also comes up short on the frames.  The Smiths know they'll be out $150 for each.  In the past four years, they've also spent at least $200 on various other unanticipated expenses.  Altogether, that is $4180 the Smiths know they will spend out-of-pocket on medical expenses this next year.

With a Flexible Spending Arrangement, even families that pay no federal income taxes save on FICA (7.65%) and any state income taxes (let's assume 5%–a conservative average).  Let's run the numbers for the Smiths for each tax bracket:

  • If they pay no federal income taxes, they would save a total of 12.65% or $529
  • At 10%, they would save a total of 22.65% or $947
  • At 15%, they would save a total of 27.65% or $1156
  • At 25%, they would save a total of 37.65% or $1574
  • At 28%, they would save a total of 40.65% or $1699
  • At 33%, they would save a total of 45.65% or $1908

What could your family do with that money?

For more detailed information on what is covered by medical FSAs, be sure to look up IRS Publication 502 for the current year here (link: http://www.irs.gov/publications/index.html).  And happy saving!

This has been a guest post by Genevieve from Bowie, MD
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