How to save 15-25% on your health care costs, Part 1

How would you like to be able to save 15-25% on your health care costs each year? And I don’t mean changing doctors or pursuing some kind of risky alternative treatments.

There really is a way you can save this kind of money each year on your health care costs. The answer is to get your health care costs paid tax-free. The net effect of this is about a 15-25% savings depending on your tax bracket.

How can you do this?

There are a couple of ways that the IRS provides for you to pay for your medical expenses with pre-tax dollars. The first is a health Flexible Spending Account or FSA. There is also something called a Health Savings Account (HSA) that works a little differently. I will talk about that in Part 2 of this post.

What is an FSA?health care costs

A Flexible Spending Account can be used to reimburse you for qualified medical expenses. Generally speaking this includes medical, dental and vision expenses where a doctor or prescription was involved. If I go to the doctor and get a prescription for some flu medicine, then those costs would be reimbursable. If I go to the drug store and buy an over-the-counter flu remedy then the costs are not reimbursable.  That’s a very general guideline. Your company’s benefits representative would be able to give you specifics or you can check out IRS publication 502.

So how does it work? Basically at the start of the year, or more likely during your benefit enrollment period, you designate a certain amount from each pay to go toward your FSA. That money will then be taken out before taxes each pay period, reducing your taxable income. The net effect of that is that any health care costs that are paid out of this FSA are done tax-free. Depending on your tax rate this means you are really saving 15-25% or more.

Benefits of an FSA

Aside from the obvious tax savings, here are some benefits of using an FSA:

  • The money is available to you immediately. Let’s say you decide to put $100 a month into your FSA. That would be $1,200 for the year. Then on February 1st you have a serious medical event that costs $950. You can pay the whole $950 out of your FSA even though at this point you have only put in $100 from January.
  • This points to the second big benefit of an FSA. It allows you to spread your medical costs out over the course of the year. Committing a $100 a month is much easier than trying to come up with that $950 the month the expense occurs.
  • Related to that is the FSA also helps your budget, since you have a known amount to plan for each month.

Drawbacks of an FSA

There are always pluses and minuses to almost anything. FSA’s have a couple of significant drawbacks.

  • First, FSA’s are only available as part of a corporate benefits package. If you are self-employed or work for a very small company that does not provide health care benefits then you are out-of-luck with regards to using an FSA.
  • Second, and this is the big one: Money you put in an FSA is a “use it or lose it” proposition. Suppose in the scenario above I committed to put $1,200 over the next year in my FSA, but then it turned out I was a little healthier than expected and I only spent $1,100 over the course of the year. That means at the end of the year I lose that other $100. Now you do have the option at the end of the year to stock up a little if you have some money to spend. Maybe buy an extra pair of eye glasses or get an  extra refill of your prescription medication  Point is though, you need to be very careful to make sure you are able to spend all of the money in your FSA or you will lose whatever savings you might have gained.

So who should do an FSA?

Is an FSA Right for you? Here are some factors to consider.

How healthy are you?

If you almost never go to the doctor, then there may be no point in bothering with the FSA as your medical costs are insignificant. Even then do you have dental or vision checkups that you pay out-of-pocket? Yearly physicals? You might consider a small amount in an FSA that would cover any out-of-pocket costs associated with preventative care.

Do you have predictable medical expenses?

FSA’s are especially useful if you have a chronic medical condition where you know you will have a certain number of doctor visits per year or particular prescriptions that are for ongoing treatment. If you have fairly regular medical expenses then an FSA is a great way to save.

Do you have an expensive procedure planned in the near future?

Planning to get LASIK surgery done? Kids need braces? If you have a larger medical procedure coming up that you can schedule appropriately then cover those costs with your FSA. This will give you the added benefit of spreading that cost over a 12 month period.

Great way to save!

If you can with some degree of confidence predict your medical expenses for the coming year and your company provides an FSA as an option then by all means take advantage of it. Just be careful to err on the side of underestimating your total expenses since any money you do not use will be lost at the end of the year. If you can make a good educated guess at your medical expenses for the coming year though FSA’s provide a great tax benefit saving you a significant amount of money.

For even more details about how an FSA works, you can check out IRS Publication 969, or talk to your HR representative to understand what your company offers.

In part 2 of this series we will look at HSA’s. They are related but work a little differently. For some people an FSA is a better fit. For others an HSA makes sense.

Photo credit: 401(K) 2012 (creative commons)

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