Does your company offer a Flexible savings account (FSA) as part of your compensation package? Do you utilize it? If you have the option to set up a FSA you probably should do so. I will tell you why, but first I should talk a little about what exactly a FSA is.

FSAs are a great vehicle for accessing pre-tax dollars for a number of eligible expenses, possibly resulting in significant payroll tax savings. However, FSA’s do have their disadvantages. Deciding whether to use your FSA benefit, as with most financial decisions, is all about making the decision that will save you the most money in the long term.

In a FSAs you elect to set aside a fixed amount of your annual salary to fund your account. This amount is then “paid back” through pre-tax deductions from your paycheck. The two main advantages of this type of account is that you are not paying any taxes on the money you have elected to set aside, and that the full amount is available right away.

There is only really one disadvantage of using a FSA account. If you do not use all of the money you have set aside in the plan year you will lose it. Gone. The money either goes back to your employer, or is spread between all the members. As you set the amount you want to fund your FSA with in the beginning of the year, you want to make sure you don’t overestimate your withholding because if you do, that money will be lost.

There are new regulations being discussed that might do away with the “use it or lose it” catch of FSAs, but as of writing this they have not be finalized or approved. Some employers do offer a grace period however, and you should talk to your HR to get the details of your specific plan.

Now that you understand the pros and cons of a FSA, its time to look into whether you should set one up or not. As I said earlier, you want to make the decision that will save you the most money over the calender year. If you have absolutely no medical expenses on average, then I would elect not to fund your FSA. As any money you fund the account with won’t be used and will just go back to your employer. I don’t know about you, but I like my money to stay mine! If you are like most of us, and have some medical expenses each year, then you probably want to choose to fund your FSA account.

The real question is how much money you decide to fund your account with. This is going to depend on what type of account your company offers. All FSAs can be used to cover eligible medical expenses, and some can also be used for daycare expenses. If you have kids in daycare you should talk to your HR rep to determine if their daycare would count as an eligible expense. The concern with funding your FSA is that if you under fund it, you will lose out on some of the tax savings, but if you over fund it – you lose that money. Obviously, it is better to error on the side of caution.

I would figure out the cost of all my mandatory medical expenses in my previous calender year, and use those to estimate what I would need in the coming year. For me these include: checkups/physical, and my yearly supply of contacts. I know I will go to the doctor 2 times a year for my eye health and that I will buy contacts for the year. I am lucky enough not to have any health ailments, nor get sick very often so it is pretty unlikely that I would rack up any more expenses during my year. As such I would fund my FSA account with just enough money to cover my baseline costs.

If you know of any large upcoming medical expenses in the following plan year, it makes sense to maximize your funding to provide you with the most tax savings possible. Talk to your HR rep about plan maximums. Good examples would be fertility treatments, or procedure like lasik. Using those pre tax dollars on your medical expenses could save you thousands.

FSAs are a great way to save money on your health care costs. It is very important not to over fund your account though, as any money left over at the end of the year will be gone forever.

Cheers!