What exactly is an FSA plan and how can it save you money? FSA stands for flexible spending account, which is a special account that is used to pay for medical expenses on a pretax basis. In other words, the money put towards the plan is not subject to income taxes and social security/medicare taxes.
An FSA plan must be set-up by your employer for the benefit of its employees. For this reason, sole proprietors, partners, and S-corporation owners are not eligible to participate. Each year you need to decide how much money you want to put towards the FSA plan, which will then be deducted equally from each paycheck. For example, if you decide to put aside $1,200 and you get paid twice each month, then $50 will be deducted from your paycheck. For a person in the highest tax bracket the tax savings would be over $500 each year! The maximum amount that can currently be contributed is $2,550.
There are of course some drawbacks to an FSA plan from both an employee and employer perspective. First, if you don’t use the full amount that you elected to set aside by the end of the year, then you will forfeit the money to your employer. The best way around this is to set aside the absolute minimum that you project you will need for medical expenses. Additionally, even if you come up a little short, the tax savings may still be much greater than the shortfall.
The drawback to the employer is the extra cost of for administration of the plan, although it is offset partially by the social security/medicare tax savings. Another point is that if an employee leaves during the beginning of the year and has already spent their maximum, you cannot ask the employee to repay you back. This is why you want to set the threshold to a reasonable level so you lower your risk.
We all seem to be paying more and more for healthcare, but the FSA plan is one way to help lower our costs by lowering our taxes. Regardless of what the current administration elects to implement regarding healthcare, an FSA plan should still remain a viable way to help us out.