33 minutes | Aug 31st 2020

#059 | The amazing tax benefits of FSAs, HSAs, and DCAs

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Though this topic might not feel exciting to some, this is the sort of stuff you need to understand.  Medical and dependent care expenses add up, and these are all vehicles and tools to help improve your financial situation.  So if they are available to you, then learn about them and use them!

FSAs - Flexible Spending Accounts

  • What is an FSA?
    • A special account you put money into that you use to pay for qualified out-of-pocket health care costs. E.g. co-pays, medicine, prescriptions, etc.  
  • Why is an FSA important?
    • It’s tax free.  This means you'll save an amount equal to the taxes you would have paid on the money you set aside.
  • What else should you know about FSAs?
    • You choose the amount you want to put into an FSA during annual benefits enrollment and then it comes out of your paycheck on a pro-rated basis throughout the year.  You cannot change the amount unless there’s a qualified event that allows you to change your overall benefits (e.g. a divorce, birth of new child, a global pandemic, etc.).  
    • The money you set aside has to be spent within the calendar year, or very close to it.  Read the fine print of your specific FSA.  There is usually a couple month grace period for filings into the next calendar year, but it’s for expenses during the calendar year you saved it in.  
    • If you don’t use/get funds reimbursed buy the deadline noted, the money gets forfeited back to your company.
    • There are maximum limits to how much you can put into an FSA, set by the federal government.  For 2020, it’s $2,650 per year per employer.  You and your spouse could both max it out if you’re expecting a big year of medical expenses
  • How do I decide how much money to put into an FSA?
    • Do your best job to estimate what your family's medical expenses will be in a future year, based on what they’ve been in the past and what you anticipate happening.  You can never plan perfectly for this.  If your family has really low medical expenses, consider a high-deductible plan and then put into an HSA which doesn’t require you to think about the amount.  
    • Plan ahead, so if you know your child will need braces in 2021 then put a big amount into your FSA.  If a big medical expense pops up mid-year, and it can wait until the following year then hold off on it and put money into an FSA to pay for it.  Plenty of medical expenses can wait.  But also, plenty can’t!  
    • Call your doctors and ask what something will cost so you know.  Forecast things out!
  • When you leave your company, what happens to the FSA?
    • Your FSA is tied to your job.  
    • Any money left unused in your FSA when you leave a job goes back to your employer.  This means you need to use it or lose it during any notice period you have of leaving a job, whether it’s your choice or not to leave.  

HSAs - Health Saving Accounts

  • What is an HSA?
    • A Health Savings Account is a type of savings account that lets you set aside pre-tax dollars for qualified medical expenses.  
  • Why is an HSA important?
    • It’s a great tax-free savings vehicle that allows you to further diversity your portfolio. 
  • What else should I know about HSAs?
    • It’s only available if you’re on a high-deductible medical plan.  We’ll do an episode soon on how to compare and think about different medical plan options for 2020, but HSAs are a meaningful reason to go high-deductible.  
    • You choose the amount you want to put into an HSA during annual benefits enrollment and then it comes out of your paycheck on a pro-rated basis throughout the year.  You cannot change the amount unless there’s a qualified event that allows you to change your overall benefits.  
    • There are maximum limits to how much you can put into an HSA, set by the federal government.  For 2020, it’s $3,550 for a single-person HSA or $7100 for a family HSA.  
    • You do NOT have to spend the money you put into an HSA in that calendar year.  You can if you need it, but you can also use it as a “savings account.”  MJT Comment - I now have 10K in an HSA and I can use it in 4 years if I have some massive ER bill for me or one of my kids.  
    • You can spend your HSA funds to pay for qualified medical expenses for any of your dependents.  
    • You can’t double-dip on HSAs and FSAs on the same expenses.  You cannot submit something for reimbursement to an FSA and then also claim it to an HSA.  
    • You generally can’t use HSAs to pay medical premiums, but it can be used for just about any other medical expenses (copayment, deductible expenses, coinsurance, etc).
  • How do I decide how much money to put into an HSA?
    • Max it out!  This is like your 401K, put as much into it as you possibly can, especially earlier on so it can grow more, tax-free, over time. 
    • When you’re 65 you can withdraw it for any reason without penalty, only paying taxes on the earnings. 
  • When you leave a company what happens?  
    • You can keep it forever and use it whenever!  
  • You need to proactively make sure your HSA funds are invested!  Otherwise they will default to sitting as cash, which is a huge missed opportunity.  
    • Make sure you invest it!  Don’t just leave it sitting as cash.  
    • My HSA requires you leave $1,000 sitting in cash, but the rest can be invested and then sold at any time to turn back into cash just like any investment.
    • Similar rules to your other investments.  
      • #1 - Choose something!  Don’t just leave it as cash
      • #2 - Read the fine print!   For example, my company offers a “MyAdvisor” tool to help you make investment suggestions, but it charges a % monthly. 

DCAs or DCFSAs 

  • What is a Dependent Care Flexible Spending Account?
    • A DCFSA or DCA is a pre-tax benefit account used to pay for eligible dependent care services.  Dependent care can include pre-school, before or after school care programs, summer camps, child or adult daycare.  
  • Why is a DCA or DCFSA important?
    • It’s a powerful tax-free savings vehicle that allows you to save pre-tax for what can be very large expenses for your children, aging parents, or other dependent expenses.  
  • What else should I know about DCA or DCFSA?
    • It’s not just for children’s expenses.  It could also be for aging parents who need care while you’re at work.  
    • You choose the amount you want to put into a DCFSA during annual benefits enrollment and then it comes out of your paycheck on a pro-rated basis throughout the year.  You cannot change the amount unless there’s a qualified event that allows you to change your overall benefits.  
    • There are maximum limits to how much you can put into an DCFSA, set by the federal government and then there may also be limits set by your company on top of that.  Your benefits enrollment system will tell you. The federal government limits in 2020 are $2500 per year if you file your tax return as married filing separately and $5,000 for joint tax returns.
    • You and your spouse can have your own DCAs, but your combined annual contributions at a household level cannot go beyond the federal limits.
    • A unique rule for DCAs that I just learned about is that your maximum annual contribution cannot exceed the lesser of you or your spouse’s salary.  So if you’re single, you cannot contribute more than you earn in a tax year.  But if you’re married, you cannot contribute more than you or your spouse earn.  So if you earn $50K or $500K, but your spouse earns $1,000 a year from a small job, then your maximum DCA contribution cannot exceed $1,000.  This is to avoid someone who has a stay-at-home spouse also filing for government benefits (tax free earnings for dependent care) when one of the people is arguably able to provide that care.  Be strategic about the worth of any odd jobs a spouse may have that limits you ability to save tax-free into a DCA.   
    • You have to spend or claim your DCA funds within the year.  
    • You can spend your DCA funds to pay for any qualified expenses for any of your dependents. 
  • How do I decide how much money to put into a DCA?
    • Plan ahead and estimate out your expenses.  A lot of companies considered this global pandemic a change in circumstance and allowed people to adjust their DCA contributions since people’s child care expenses suddenly drastically changed.  
    • 2.  
  • When you leave a company what happens to your DCA?
    • Your FSA is tied to your job.  
    • Any money left unused in your FSA when you leave a job goes back to your employer.  This means you need to use it or lose it during any notice period you have of leaving a job, whether it’s your choice or not to leave.  The goods news is the funds are pro-rated coming out of your paycheck so it’s likely you have incurred those expenses and can file for reimbursement before you leave.  

Top 3 Takeaways:

  1. You should always take advantage of these accounts when available.
  2. The benefit of these accounts is the tax savings, and though it may not feel like immediate money in your hands, each tool has huge savings benefits that will help you save money and grow your net worth.  
  3. Be thoughtful and plan ahead to know your expenses and how to best utilize these accounts.

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Mike’s Book:  Your New Relationship with Money

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