Creatively using Flexible Spending Accounts (FSA)

2008 is the first year I decided to sign up for the company Flexible Spending Account (FSA). It is an account that is designed to deduct a fixed amount of money each pay period, in which the total amount can be used for most medical, dental, and vision expenses. From that statement, there is no benefit over just a regular savings account, but I will get into the benefits to use to your financial advantage.

Like a 401(k), the amount deducted from a Flexible Spending Account is pre-tax. That means if I make $1000 in a pay period but elect to deduct $50 towards an FSA, then I will only be taxed on the remaining $950. A 401(k) contribution defers taxes for federal and state, but a Flexible Spending Account deduction defers taxes for all taxes - federal, state, social security, and Medicare.

The contribution of a 401(k) can be changed anytime during the year from $0 to the maximum annual limit. With a Flexible Spending Account, the total amount a person wants to contribute has to be decided before the year even starts, and the amount deducted each week is the total amount divided by the number of pay periods. I decided that I wanted to have a total of $250 of Flexible Spending, and because I get paid bi-weekly (26 pay periods per year), I have $9.62 deducted bi-weekly towards my Flexible Spending. But say I want to use $200 of my $250 that I want to contribute to an FSA, and it's only February. At most, I've had about 4 pay periods with a total contribution of just under $40. One good thing about FSA is that you can spend the total amount you elected to deduct for the entire year, even if you haven't contributed to the full amount yet. So I could go ahead and make that eligible $200 purchase towards Flexible Spending. If I left the company, I would not have to pay the difference either. But with one good benefit comes one disadvantage.

Flexible Spending Accounts have limits to when you can use them. The funds do not rollover from year to year. They have the "use it or lose it" rule. Whatever funds that do not get exhausted from Flexible Spending are lost and do not get returned to the recipient. But most plans have a grace period. In my case, the 2008 FSA is good for the entire 2008, plus 3 months grace period until about March 15. The grace period is similar to contributions to an IRA, which can be made to the prior year until taxes are due.

My $250 total Flexible Spending is small because I am single without dependents. I will primarily use it for prescriptions every now and then, but mostly for contact lens solution and accessories. My vision plan at work should cover the cost of contact lenses, otherwise I would have budgeted those into my FSA contribution. Last year I spent about $600 out-of-pocket on prescription glasses. If I had an FSA setup, I would have $150 on federal taxes alone being in the 25% tax bracket. I still would have saved on state taxes, social security, and Medicare.

There are many items that Flexible Spending can be used on - from co-pays to deductibles, to prescriptions, to dependent-care, to medical, dental, or vision. The list is big, and mostly consists of needed medical expenses. Cosmetic enhancements, if not a necessity, are not covered. Some companies even have a debit-card program, so the funds are available to spend right away. Companies that reimburse funds are not the most convenient, but reimbursement method can be used to the advantage of the user.

With my Amex Blue Cash, I get 5% cash back on drug store purchases. So if I had in $50 prescriptions, I would use my credit card to pay for it and receive $2.50 (5%) in cash back. I would then submit my receipts for reimbursement and get back my original $50. I would have made $2.50, for buying something I would have needed anyway.

One of my prescriptions always comes with a rebate. It is a $30 rebate for a very expensive drug. My prescription co-pay is either $10, $20, or $30 depending on the brand, and for the expensive drug, it is $30. I would put the $30 on my credit card, get 5% cash back, submit a copy of my receipt for $30 FSA reimbursement, and submit another copy of my receipt for $30 rebate. Now I just made $30 + 5%.

Today I came up with another technique to use to my advantage. My sister frequently buys prescriptions for her daughter. Her husband's company does not offer Flexible Spending so obviously she can't get reimbursed for her prescriptions. But she can give me the receipts, and I can submit them to get reimbursed for her purchase. I would get the reimbused money back, but because I did not actually pay for my sister's prescriptions, I could use the money for whatever I want. In essence, I received money earned from work tax-free. Now my goal is to get any receipts with Flexible Spending items from other family members. Most of them pay in cash, so credit card names wouldn't show up on the store receipt.

Next year, I will have to increase my Flexible Spending Account to a higher amount to include eligible purchases from my family, that I can use to claim for myself. Just a nice little loophole to avoiding all taxes.