Looking for creative ways to boost your retirement savings? Don’t sleep on the benefits of a Flexible Spending Account (FSA)! As someone late to saving for retirement, I became an expert in finding every conceivable way to increase my retirement savings as quickly as possible. If you are looking to save money, an FSA can be a great tool for you, too.
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One full year had gone by since I started my social work position with my local county. It turned out to be a job that I loved. But I had to wonder if I was taking advantage of all my benefits. Using an FSA to save money on health care hadn’t been on my radar.
As my focus on financial independence and catching up my retirement savings became stronger, I decided to find out more about this money-saving, tax optimization tool.
Here is what I learned about Flexible Spending Accounts . . .
Table of Contents
What Is A Flexible Spending Account?
Actually, FSAs are not accounts, but tax arrangements. A Flexible Spending Arrangement allows your employer to set aside some of your pre-tax earnings. You get to spend it on qualified health and/or dependent care expenses.
The portion of your earned income that is funneled into your FSA completely bypasses federal income tax, Social Security tax, and Medicare tax.
This allows you to pay for qualified out-of-pocket medical expenses or dependent care expenses with pre-tax rather than after-tax income.
What Plans Are Available Within A Flexible Spending Account?
An FSA is only an option if your employer offers it as part of your employee benefit package. Check with your HR department to see what is offered.
There are two types of Flexible Spending Account plans, the Health FSA and the Dependent Care Assistance Plan.
Health FSA
The Health FSA covers medical, dental and vision expenses that your regular health insurance doesn’t.
We’re talking about co-pays, deductibles, glasses, hearing aids, medical equipment, smoking cessation programs, over-the-counter medications, and more. Out of pocket expenses can add up, as I learned when my husband almost died from a ruptured brain aneurysm!
Dependent Care Assistance Plan
The Dependent Care Assistance Plan covers childcare and afterschool program expenses or elder care so that you and your spouse can go to work.
Quality childcare is expensive. If you don’t have a source of free or alternative childcare, paying for dependent care will eat into your budget. This can make saving for retirement harder. Take advantage of the Dependent Care Assistance Plan to save money if you can!
How Much Can You Contribute?
You get to decide how much of your income you want to have set aside each year, within the plan’s limits. This is your annual FSA election amount.
You must stay within the plan’s minimum and maximum annual election amounts.
Annual Contribution Limits
The IRS sets the maximum contribution limits for the Health FSA, which is indexed for inflation and may change from year to year. Check out the IRS announcement on their website for updates each year.
For 2024, the maximum annual election amount for a Health FSA increased to $3,200 (up $150 from the 2023 maximum).
In 2025, the Health FSA annual maximum contribution limit will increase by $100, going from $3,200 up to $3,300.
The Dependent Care Assistance Plan maximum did not change for 2024. It continues to be limited to $5,000 per household (or $2,500 if you are married and file separate tax returns).
If your spouse is a full-time student or disabled and unable to work, the maximum annual election for the Dependent Care Assistance Plan is $3,000 for one child. For two or more children, it is $5,000.
When Can You Enroll In A Flexible Spending Account?
If your employer offers this benefit, you can enroll upon being hired, during the annual enrollment period, or if you have a qualifying event.
You may have a qualifying event if you get married, divorced, your spouse passes away, you have a baby or adopt a child. You must enroll within a set amount of time of the qualifying event.
What Are The Benefits Of A Flexible Spending Account?
There are several attractive benefits to using a Flexible Spending Account or FSA. It’s a great way to save money on taxes, medical or dental expenses, and even childcare costs.
Get Substantial Tax Savings With An FSA
Contributions to your FSA are deducted from your income before taxes. This means you can save 30-40% on the dollar (depending on your tax bracket).
To illustrate this, consider that you must earn $520 to take home $400 after taxes.
By using a Flexible Spending Account, you only need to earn $400 to cover qualified expenses.
Back in 2018, I used an online calculator to figure out how much I would save by contributing the maximum to my Health FSA that year. It was about $782, which was money I could redirect into my retirement savings!
Boost Your Retirement Saving Rate With An FSA
If you’re trying to catch-up your retirement savings after a late start, increasing your saving rate will make a huge difference. Every dollar you save by paying for medical expenses or dependent care costs with pre-tax money will free up more cash to help you reach your retirement savings goal.
Using a simple interest calculator, I figured my $782 savings from funding my Health FSA would nearly double at 6% interest over 10 years.
This is not to say that the money in your FSA can be saved for more than one year. In most cases it can’t.
The FSA Is Not An Actual Savings Account, However
It is a benefit provided by your employer that allows you to use pre-tax earnings to cover your annual dependent care expenses or out-of-pocket medical expenses.
But if I take the amount of my projected savings and set aside the same amount in after-tax funds into my brokerage account, it will help boost my savings for my future retirement.
I learned to think outside of the box when it came to growing my retirement nest egg after I discovered the Financially Independent Retire Early (FIRE) community.
The FIRE community helped me to see that it’s not too late to catch up my retirement savings, even after a late start. Learning that every little bit I could throw at my savings would add up was inspirational.
Books about financial independence and FIRE gave me the winning strategies.
Are There Any Downsides?
Yes, Flexible Saving Accounts are a “use it or lose it” proposition.
Use It Or Lose It
You must plan very carefully. If you don’t use up all the pre-tax funds in your FSA within the calendar year, you lose it. The money’s gone!
I was worried about this when I signed up for an FSA for the very first time in 2017. I was afraid I wouldn’t spend all the money. However, my conservative contribution of $500 was completely used up before the year was over.
I could have contributed more.
For 2018, I decided to contribute the max to my Health FSA. I carefully reviewed what we expected to be spending on out-of-pocket health care costs.
As it turned out, I estimated correctly, and we used up all the pre-tax money set aside in my FSA during 2018. For 2019 I decided to max out my FSA contribution again. For the final year I was employed in this job (2023), which was only three months, I decided not to contribute to my FSA. My priority was on contributing to my retirement plan instead.
Not Every Plan Will Allow Carryovers
My employer did allow for a roll-over of $500, so I felt a little better about contributing the max to my FSA the first time I did it. But if I had underspent by $600, I would have lost $100 since only $500 carried over.
Due to COVID-19 and the global pandemic, the IRS also allowed all employees to rollover up to $550 (from 2020 to 2021) of unspent FSA funds. To see if your current FSA plan allows rollovers, check with your employer. Not all company plans allow this, but if your plan does, the maximum carryover for 2024 is $610.
In 2025, the maximum carryover of unused funds will increase slightly. If you have an FSA plan that permits it, the maximum carryover amount in 2025 will be $660, an increase from $640 in 2024.
Each year I had to guess how much we might spend on out-of-pocket medical costs. So the amount I contributed to my FSA varied from year to year. Even if I didn’t contribute the maximum, I knew I would be saving money by contributing something.
Is It Worth It To Contribute To A Flexible Spending Account?
Yes, I think it is. It was definitely worth it to contribute to an FSA for my family. It allowed me to free up more funds to use for catching up my retirement savings after a late start.
At the time, we didn’t have childcare expenses, but we did expect to have out-of-pocket health care costs that were not going to be covered by our insurance.
We could have set up sinking funds to save for out-of-pocket health expenses. However, I realized we’d get more bang for our buck by using pre-tax dollars to pay for those expenses.
I learned that it was important to re-evaluate participation in my FSA each year. For the years my family expected to have less health care costs, I contributed less to the FSA. This was due to the “use it or lose it” status of FSA funds. In addition, I made sure to use all my FSA funds before each year’s end.
Take advantage of a health or dependent care FSA if you have access to one. It will absolutely help you save money.
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Question: Do you have access to a Flexible Savings Account at your job? What steps do you take to make sure you use up all the funds?
Great breakdown on the FSA Kathy! I like the FSA but the HSA combined with a HDHP is even better. Of course, it’s apples and oranges because of the plan types. FSA is great as long as you can spend that money and everyone I talk to about it has some sort of method to get rid of the funds.
Thanks for stopping by, Matt!
Yes, a Health Savings Account (HSA) combined with a High Deductible Health Plan (HDHP) can be a great way to lower monthly insurance premiums, and although you usually end up paying more for out of pocket medical expenses due to the higher deductible, at least you get to do it with pre-tax income. A definite win!
In my case, monthly health insurance premiums are covered by my employer (for myself and my family, which I know is rare). So although the Flexible Spending Account (FSA) is a use it or lose it proposition, it’s the best bet for me to increase tax-optimization and I’ll add the amount saved into my retirement fund.
I think you’re right, that if people make the effort to sign up for an FSA, they usually make sure they use up the funds!
Great breakdown! My FSA used to be use it or lose it if I didn’t spend it all that calendar year but last year they started offering the $500 rollover you mentioned. It’s definitely helped a bunch as it was very difficult to exactly estimate how much you’re going to spend the following year on medical expenses. The pretax benefit is a great way to save money with little effort required.
I agree, MC, that it can be difficult to predict how much money you should set aside in an FSA each year because it’s how to predict what your medical expenses might be for the next 12 months. I try to come up with an estimate based on our past needs and any upcoming expenses (like extensive dental work, glasses, etc.).
Thanks for stopping by, MC!
That’s a really informative post. Well explained. Thanks for sharing this.
Glad you found it helpful, Manju!
I’ve always want back and forth on whether I should get or even need a FSA. Thanks for the breakdown it’s very informative.
Glad you found it helpful, Sdot! It took me a couple years to make the leap into using the FSA, but it has really helped me save money.
This is a beautiful wealth of information! Thank you so much for sharing this with me!!! I am going to definitely bookmark this post and share! Wow! Just amazing. This post will help so many people.
Thank you, Lisamarie! This information is so useful during open enrollment every year.
Interesting read! I haven’t heard about an FSA here in Canada. I’ll have to look into it so I can save money better. Thank you for sharing x
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Glad you enjoyed the post, Lynn! I’m not sure what’s available in Canada. If you find out, please let us know!