Be Cautious When Funding FSAs

Flexible spending accounts might not be such a good idea for people who aren't prepared to claim all their contributions back over the course of the year.

Many prudent people put money aside all year into employers' FSAs for health care, using it to help defray the costs of medical bills.

There are even handy debit-type cards given out by health-plan providers such as Aetna (AET), UnitedHealth Group (UNH) or even a specialist benefits company.

But many people don't manage the plan thoroughly, and end up forgetting to claim some amount of money.

Imagine, for example, someone contributes $100 a month in pretax income to his employer's FSA plan on the basis of his estimate of his annual out-of-pocket medical expenses. At year's end, he finds that he has a couple of months of savings unused -- say, $200.

But at the end of the year (or up to two months and fifteen days later, if his employer allows), any unspent money is removed from the account and becomes the employer's.

A spokesman for the IRS said the agency doesn't track FSAs, so is unable to estimate how many employees contribute to FSAs.

However, in an interview with Minnesota Public Radio last December, Blaine Bos, a partner at the consulting firm Mercer, owned by Marsh &McLennan(MMC), said that 21% of employees use FSAs, and on average, they lose less than $60 each.

With 146 million employees in the U.S., according to the U.S. Department of Labor's April 2007 employment statistics, a potential 30.6 million employees lose a staggering $1.8 billion dollars each year because they overestimated their medical expenses.

Of course, the plan is pre-funded by employers, so the other side of the coin is that employees are entitled to spend all of their future contributions in month one, and just keep making the monthly deductions from their wages throughout the year. And if they leave the company, it's possible they might not make all the scheduled contributions, and could come out ahead in the process.

Even if you do use one of these FSAs, and work out that you must spend all of your money in there to see any benefit at all, isn't it at all possible that you will be incurring health expenses at the end of the year just to spend the account in full?

All health related companies (eyewear, pharmacies etc.) see a rush at the end of the year as all the previously healthy people rush in to spend their FSAs.

Remember that this medical FSA money has to be spent in an approved manner. You can't just pop out and purchase some K-Y brand Yours+Mine from Johnson & Johnson (JNJ), no matter how compelling the advertising. You have to spend the money on specific medical expenses.

It's also possible that these late spenders will incur extra costs for their health-insurance plans. As a result, the margin of profit on the health plan goes down, and is likely to increase the cost of health insurance down the road.

Something else to consider is that because you don't pay Social Security taxes on your FSA, the amount of pay used to determine your Social Security benefits at retirement may also be reduced.

So health-care FSAs can cost the employees when they lose any unspent savings, may reduce the amount of Social Security checks in retirement and can increase unnecessary spending on healthcare.

Unless you find it impossible to resist spending your money if it gets into your bank account, have significant known medical expenses or earn a sufficient amount to make it a real tax benefit (65% of taxpayers earn less than $50,000), it would probably be a better bet to simply pay your bills each month from your check.

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