Friday, November 13, 2009

Flexible Spending Accounts: Part 2 – Calculating a Safe Contribution

If you aren’t participating in your Flexible Spending Account, you’re literally giving money to the Internal Revenue Service unnecessarily. Still, if you go overboard on your contributions you can lose money

Start calculating a “safe” flexible spending account contribution by listing everything you spent out of pocket on health care last year. Capture the description and out of pocket expenditure for each line item. Classify each item as covered or not covered and repeatable or not repeatable.

Example Expense List:

Annual physical exam; $25; covered; repeatable
Blood work for physical exam; $25; covered repeatable
Semi-annual dental exam; $30; covered; repeatable
Emergency room; $150; covered; not repeatable
Aspirin; $12; covered; repeatable
Multivitamins; $10; not covered; repeatable
Band-Aids; $4, covered, repeatable
Nail Clippers; $3; not covered; not repeatable
Wrist Brace; $7; covered; not repeatable
Shampoo; $4; not covered; repeatable

Covered expenses include co-pays for medical, dental, and vision office visits, lab work and tests, and any hospitalization or emergency medical expenses. Out of pocket expenses for prescription and over-the-counter medications are covered as are prescription and over-the-counter medical devices and supplies.

In general, if you incur the expense to heal, cure, or control pain then it’s probably covered. If it’s a “wellness” expense - like vitamins, food supplements, or exercise equipment - it’s probably not covered unless your doctor wrote a prescription ordering you to incur the expense.

Total the annual amount twice – once with all covered expenses and once with only those covered expenses that are repeatable.

Example (using the Expenses List):

Total of all covered items = (25+30+150+12+4+7) = $228
Total of covered & repeatable items = (25+30+12+4) = $71

Odds are good that your list will be much longer and the totals much higher than the example– but let’s continue to use the Example List.

Next, you need to know your approximate income tax rate. You can calculate an estimate of your income tax rate from last year’s Form 1040. Look up your actual tax paid and your adjusted gross income from your Form 1040.

Example Form 1040 Information:

Tax Paid = $10,000
Adjusted Gross Income = $40,000

Then divide the Tax Paid by the Adjusted Gross Income ($10,000/$40,000 = 0.25) then multiply by 100 to convert the result to a percentage (0.25 * 100 = 25%)

Example Income Tax Rate = 25%

Example “Safe” Contribution:

If you now divide the Total of covered & repeatable items ($71) by your Income Tax Rate subtracted from one (1 – 0.25 = 0.75); so $71 divided by 0.75 = $95. The result ($95) is the amount greater than the covered repeatable amount that you can contribute with nearly complete safety.

It is likely that there will also be covered non-repeatable expenses in the coming year and taking a conservative guess at them will allow you to increase the safe contribution. You may even plan non-repeatable expenses; for example, the purchase of glasses or perhaps laser eye surgery. The cost of planned expenses can be directly added to the safe contribution figure.

Once you have a year or two of experience using your flexible spending account you can simply adjust your contribution up or down based on experience.

There’s really no excuse for not getting started.

Link to Other Topics in the Special Report: Cutting Expenses

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