Sunday, March 9, 2014

Flexible Spending Account (FSA) – A real life illustration

We have known for a couple of years that braces (orthodontia treatment) had been recommended for my son.  During 2013, my wife expressed the desire to obtain orthodontia treatment as well.  As we approached the close of 2013, we made an appointment for a consult with a local orthodontist to begin the process to obtain a guesstimate as to the cost.  I was well aware that there have been many changes to Flexible Spending Account (FSA) as a result of the Affordable Healthcare Act.  In retrospect, the need for a consult may have been a case of wishful thinking as we were reassured that the cost of orthodontia care would well exceed the $2500 maximum for FSA.  FSA (unlike a Health Savings Account), is “use or lose” – this drawback cannot be stressed enough.  FSA is not a good vehicle to plan for unexpected (emergency) health care as if you do not use the funds that you have budgeted for your FSA, you will lose this money.

Thus, for us, planning a FSA amount for 2014 became an easy thing – we knew with little uncertainty that we would be able to use the entire $2500.  For most, establishing a FSA is done during open enrollment which is often around November – December.  The amount established for your FSA is spread and deducted from your pay check using before tax dollars (in other words this money is tax free).  As I identified the maximum of $2500, this amount was spread into 25 payments of $97 with the 26th payment being the balance to bring the amount to $2500.  While some may react to this by saying, “I can’t take a $100 hit to my paycheck,” let’s dig a little deeper.  First, as I stated, the money is pulled from your paycheck with before tax dollars.  In my case, that $97 may equate to a change in my net pay of only $70 - $80.  Second, if you decide that you are going to get the medical treatment, you will need to pay for that medical treatment one way or another – which way sounds better to you – a manner where you can avoid paying taxes on much of the cost OR a way where you not only pay taxes on the cost of your medical care, but may also need to borrow (and pay interest)?

In early 2014, we have made appointments with the orthodontist’s office to initiate care.  Coincidentally, the treatment package for both my wife and son was $4500 each.  As we knew that orthodontia treatment was in our future, I had planned and selected dental plans accordingly in the years prior.  As it worked out, the dental plan that was selected will pay up to $3500 for my son and also has a provision for adult orthodontia treatment which will pay up to $1500 for my wife.  This (roughly) leaves about $1000 owed for my son and $3000 for my wife.  I had explored trying to do something tricky so that I could allocate and pay a portion from a FSA in 2015, but the orthodontia office identified their requirements for payment which did not fit neatly to this scheme.  On the upside, the orthodontia office did identify that they extend a 5% discount if we paid our portion up front.  Further, they advised us that they would accept cash, check or charge for this upfront payment.  “Charge” was music to my ears as I have credit cards that offers 1% cash back (my wife also had a rewards card which provided a benefit of similar or perhaps slightly greater value).  As a result, we decided to pay our portion up front using charge cards which also would give us a grace period to recoup the $2500 from the FSA.  (Based on prior experience, my FSA generally takes about 10 days to process and funds are deposited electronically into our account).  Also, it is noteworthy to point out that although it is only March, and I haven’t contributed the full $2500, the full amount of the FSA is available to you for reimbursement of qualified medical expenses on day one of the calendar year.

So let’s get down to the savings.  I took a look at my Federal and State tax forms to get an estimate of the percentage that I was actually getting taxed.  To do this, I used the taxable income as the denominator and the tax amount from the tax table as the numerator.  My result was about 13% on Federal and about 5% on State (this may be considered conservative as additional taxable income could potentially drive up these percentages).  Thus, on $2500, I estimated that the use of FSA saved tax expenses of around $325 for Federal and $143.25 for State.  Additionally, by planning for this medical expense instead of borrowing, I was not only able to avoid finance charges, but received the 5% prepayment discount.  For my son, this amounted to around $50 and for my wife around $150.  And finally, the ability to use a rewards / cash back type credit card provided an additional benefit of around $10 for my son and $30 for my wife.

No matter how you slice it, orthodontia treatment is a sizable expense.  In this situation, FSA is a great option.  However, as reflected here, due to FSA being "use or lose," it is not a good vehicle for unexpected medical expenses.  Also, I will lament that it would have been nice to have worked with the pre-Affordable Healthcare Act FSA maximum which used to be $5,000 and which would have permitted even greater savings.  As many of us have learned, the "Affordable" part of this act seems to be for only some; for us "others" healthcare has become less affordable.