My $280 Mistake

I admit it. I goofed. Despite being a financial planner who often helps people with their benefits, I made a mistake with my own. As I was looking at my expenses and taxes for last year, I realized that I could have reduced my taxes by $230. That’s the amount I would have saved if I contributed the $817 I spent on eligible vision and dental expenses last year to my company’s limited-purpose FSA (flexible spending account).

So what is an FSA? An FSA allows you to put money aside pre-tax and then withdraw it tax-free for health or dependent care expenses (depending on the type of FSA). Since I’m in the 28% tax bracket, that’s a 28% discount on any of those expenses I use the FSA for.

Now, there are a few caveats to be aware of. One is that if you also have an HSA (health savings account) like I do, you can only contribute to a limited-purpose FSA, which is restricted to qualified dental and vision expenses, and you can’t use both your HSA and your FSA for the same expenses. (It’s much better to use your FSA first because of the following caveat…)

The second caveat is that unlike with an HSA, you generally lose whatever you don’t use from your FSA by the end of the year. I say “generally” because some FSAs allow you to carry over the money for a few extra months or like my company, up to $500 indefinitely. In any case, this means that you don’t want to over-fund your FSA (the limit is $2,550 for 2015).

For this reason, it’s best to first max out an HSA if you’re eligible. That way you keep whatever you don’t use and you can even invest it to be used for future health care expenses (including most Medicare premiums) tax-free or once you turn age 65, for any purpose without the normal 20% penalty for non-qualified withdrawals. (You’ll still owe taxes if you don’t use it for qualified medical expenses). In fact, the tax benefits of the HSA are so significant you might even want to max it out before your 401(k) as long as you’re getting your employer’s match.

If you don’t have an HSA or if you’ve maxed it out, the best way to use an FSA is for the expenses you know you’ll have during the year like routine checkups, glasses and/or contact lenses, and prescription drugs. If you can carry over $500 to the next year, you can contribute at least that $500. Otherwise, you face the risk of forfeiting any money over $500 that you don’t use.

In retrospect, maybe my mistake wasn’t so bad. Since I didn’t expect to spend that much on dental and vision expenses, I wouldn’t have known to put $817 in my FSA. But even if I had only contributed $500, that still would have saved me $140 in taxes

Unfortunately, I’ll make the same mistake again as the deadline has already passed to enroll in my FSA for this year, costing me another $140 in taxes this year for a total of $280 (more than enough to pay for the home theater system I recently bought). Oh well. There’s always 2016…

 

 

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