A 3 Step Guide to Planning Flexible Spending Account (FSA) Contributions

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I received the e-mail from my human resource manager last week. It’s open enrollment season!

The company I work for provides employees one health insurance option. There isn’t much excitement there. But they pay 100% of the premiums, so I won’t complain about the lack of choice. What I nerdily look forward to is planning my health Flexible Spending Account (FSA) contributions for the following year.

If you’re unfamiliar with FSAs, here are the basics:

• Your contributions to an FSA are excluded from gross income. Meaning, they’re not subject to federal income, Social Security, or Medicare taxes.

• FSA funds can be used to pay the out-of-pocket costs for qualified medical expenses. Unless you have one of ‘em “Cadillac” health care plans, you’re gonna have some out-of-pocket medical costs.

• Your entire annual contribution is available for use at the beginning of the year. Employers usually deduct an equal portion from each paycheck. If you’re smart, you’ll take care of your more expensive health related matters earlier than later in the year.

• There is no legal limit on how much you can contribute to a health FSA, but your employer is required to establish a cap on how much employees can contribute.

• You can only change your contribution amount if you experience a major life event, e.g., you get married or have a baby.

• FSAs are “use it or lose it.” Generally, you’ll have to forfeit any unused balance remaining in your FSA.

And now you’re scared.

First, depending on the option provided by your employer, you may have up to two and half months after the end of the plan year to incur additional medical expenses that can be  paid from the prior year’s balance.

Second, careful planning can mitigate your risk of loss.

Depending on the size of your family and the craptastic nature of your health insurance, we could be talking major savings here.

It may be tempting to neglect this area of financial planning altogether since Obamacare is on the horizon, but don’t. Last I heard, only 2% of Americans who didn’t qualify for Medicare would find the public option plan appealing enough to sign up. Oh, and it costs slightly more than private insurance. We’ll let our elected leaders hash out the details. For now, we plan.

Here’s my step by step planning process for estimating the out-of-pocket costs of qualified medical expenses.

Step 1: Calculate annual co-payments for prescription medication taken on a recurring basis, e.g. birth control, or used to treat chronic medical conditions. You’ll likely take this medication all year. Exclude the cost of any drugs you might be prescribed for treatment of a non-recurring illness, e.g., strep throat.

Step 2: Consider your responsibility for routine medical evaluations like gynecological or prostate exams, mammograms, teeth cleanings, eye exams, or physicals.

Step 3: Work with your doctor and insurer to find out what your financial obligation will be for medical procedures you’ve been putting off. This in and of itself is a project. We’ll use a dental procedure as an example since dental insurance usually sucks, and you’ll probably be on the hook for a significant portion of the costs.

3a) Find out how much the procedure will cost. While you’re at it, get the procedure code(s) from your dentist. You’ll need to provide this information to your insurer in the next step.

3b) Ask your insurer how much they’ll cover for the procedure. It’s not enough to simply ask for the reimbursement rate. If you’re picky enough to use an out-of-network provider (essentially a doctor that doesn’t have contractually established rates with your insurer), you could be paying more than you initially thought. For out-of-network doctors, your insurer will only pay for a percentage of “reasonable and customary fees.”

Let’s say your dentist charges $1,500 dollars for a crown. Your insurer will pay 70% of what they’ve deemed reasonable and customary. Say $1,000. Your responsibility is $800 (30% of $1,000 not reimbursed by your insurer plus an additional $500) even before you add in your gotcha deductible of $50.

If you find yourself in a position where you still have money left in an FSA that you don’t know what do with, take a look at some of the more surprising qualified medical expenses.

• Abortion (I’m not suggesting you undergo such a procedure just to avoid losing money in your FSA.)

• Acupuncture

• Bandages

• Condoms and spermicide

• Contact lenses, saline solution, and enzyme cleaner

• Eye surgery to correct vision such as LASIK

• Fertility treatments, e.g., in vitro fertilization

• Pregnancy test kit

• Sterilization (I’m also not suggesting you go through this procedure to prevent forfeiting funds in your FSA)

For the entire listing of qualified medical expenses, refer to IRS Publication 502 Medical and Dental Expenses.

You can go through a more extensive planning process to identify additional savings, but I’d rather err on the side of underestimating my medical expenses given the risk of losing unused FSA contributions.

Do you contribute to an FSA? If not, what are you afraid of? If you do, what have I missed in planning FSA contributions?