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A FSA, or flexible spending account, is a federally approved, employer-administered account to which you can contribute money that you then use to pay for out-of-pocket medical expenses. FSAs are woefully misunderstood and underutilized by American families. FSAs provide benefits a couple of different ways. First, the money you deposit into your FSA does not get taxed. The money is deducted from your pay before your employer calculates Medicare, Social Security, and income taxes.
For someone in the 28 percent tax bracket, every dollar you deposit to an FSA, you can cut your federal income tax bill by $0.28. If you place $3,000 a year into your FSA, that would result in a savings of $840. The other great thing about FSAs is that even though the total amount of the contribution will be deducted from your pay in equal installments throughout the calendar year, you can file claims against the full contribution from Day One as if it were sitting in your account already. For example, if you three family members will need new eyeglasses, schedule your eye exams and purchase your glasses in January. Even if the bill is $1,500 and you've only deposited $150 to your FSA, you can submit your receipts and receive reimbursement from your FSA for the full $1,500. The only time this can come back to bite you is if you leave your job mid-year. At that point, you would need to make an additional contribution to cover the benefits that had been paid to date.
Be careful when you estimate your annual FSA contribution, because if you overestimate and do not use all the money, it reverts to your employer who then uses it to offset the overall cost to provide employee benefits. Also, while FSA contributions can be used to pay for just about any out-of-pocket medical expense from co-pays to over-the-counter medications, FSA contributions cannot be used to pay for family health insurance premiums.