[Updated for 2012 and 2013 limits] Flexible Spending Accounts (FSA) have been around for a while now and many families use them as a tax advantaged way to save for health care related costs. However, FSA have and are about to undergo some relatively significant changes due to provisions in President Obama’s health care reform. If you use FSA or similar pre-tax accounts like a Health or Dependent Care Savings Account these are changes you should be aware of, particularly during open enrollment when you make your FSA allocations for the year ahead.
Many employers offer Flexible Spending Accounts (FSA) to their employees. This is an account where a certain amount of money is deducted from an employee’s paycheck and placed in to an account that is used to pay for authorized medical expenses. These expenses include doctor’s visits, prescription medication, eyeglasses and often, non-doctor prescribed products such as over the counter medication. In 2012, as was the case in 2011 and 2010, there are currently no mandated limits on FSA accounts. But most employers generally set their employees maximum contribution somewhere between $2,500 and $5,000.
Because these funds are deducted on a pre-tax basis, no tax is paid on the contributions. This means that the employee is essentially getting a discount on medical expenses equal to their effective tax rate, often representing hundreds of dollars in savings over the course of the year that these funds can be used. However, any unused FSA funds at the end of the plan year are forfeited by the employee, known as the use-it or lose-it feature. That is why you must spend time planning your FSA contribution and only put away what you can reasonably expect to spend.
As a result of new health care laws and the need to fund them, the eligibility and contribution limits concerning these accounts are going to change . There are two main changes in particular which have the potential to seriously impact a consumer’s health care costs.
- [From January 2011] A Flexible Spending Account can NO longer be used to pay for over the counter (OTC) products, unless they are prescribed by a doctor. Some drugs, including insulin, will be exempt from this rule. For doctor’s to prescribe an OTC drug, they will need to show cause that the drug is a necessity for the patient. This new exception only applies to purchases made on or after January 1, 2011, so claims for medicines or drugs purchased without a prescription before this date can still be reimbursed in 2011.
- [From January 2013] Employees may only contribute a maximum of $2,500. This will be adjusted annually to account for inflation and is per employee, regardless of whether you cover just yourself or your full family. Because it is per employee, if a husband and their spouse both work they can both claim the $2500, for a total household limit of $5000.
While the limits on over the counter purchases apply to health savings accounts as well as FSA, changes to health savings accounts are minimal. For people who have Health Savings Accounts (HSA) the penalty for using the money for unqualified expenses (like OTC drugs) will increase from 10% to 20%.
How does this translate to the average American?
According to savemyflexplan.org, an employee who is in the 28% tax bracket and contributing $2,000 to their FSA each year could see their annual medical expenses increase by approximately $780 in 2011. This estimate doesn’t take in to account state taxes, so for those with a state income tax the amount could be significantly higher.
For most employees though, capping the funding limit at $2,500 won’t have an impact. According to Hewitt Associates, the average amount contributed to employee sponsored FSAs in 2009 was only $1,535, well below the $2,500 new limit.
Wait until 2013? Headaches and Hassles with the new rules
Some lawmakers and industry groups have called for clarification of the new health care regulations to give providers and retailers an opportunity to educate consumers and develop compliance procedures.
The first and most talked about issue with the new law is the wording. Does a doctor have to write a prescription for over the counter medication or is a letter of medical necessity enough? If a prescription is necessary, family practice doctors who are already at a shortage and not able to schedule all patients in a timely fashion, could be overloaded with patients simply wanting a prescription for Tylenol. Family practice doctors don’t want to fill their schedules with requests such as this because these appointments aren’t largely profitable to their practice.
If a letter of medical necessity is needed, this could be left to a doctor’s office staff but the volume of people wanting a letter could overwhelm them. Tasks like insurance paperwork and large volumes of phone calls already have doctor’s offices operating at capacity. This new law could seriously degrade the quality of service, some argue.
Next, some drugs are exempt from the over the counter rule but for those companies who are charged with verifying compliance, they may need more time to train employees and consumers once the rules are clarified.
Finally, retailers will have to make changes to electronic systems that help to verify compliance. Reprogramming these systems takes a lot of time and come at a large expense. With the rules still unclear, reprogramming can’t take place until all questions are answered.
For those who have HSAs or FSAs, the new laws will start going into effect at the beginning of the calendar year unless congress intervenes. Employees are advised to check with their employer for clarification of the new rules and how they affect their individual plan.