A Flexible Spending Account (FSA), is a special account set up through your employer that allows you to set aside a portion of your income to pay for qualified medical expenses, including braces, on a pre-tax basis through salary reduction. The FSA contribution limit was $2,550 in 2016, but this limit will increase to $2,600 in 2017.
Despite the significant benefit of contributing to these accounts “before taxes,” one potential drawback is the “use it or lose it” rule. This rule states that any amount over $500 not spent “within the coverage period” will be forfeited, although amounts up to $500 may be carried over to the following year. An amount that is carried over does not affect or count against the next year’s salary reduction limit.
Side note: Making a down payment for braces is a smart way to “spend down” the amount in your FSA, if needed, to avoid the “use it or lose it” rule. You would still be able to use your FSA again for braces or other orthodontic treatment in the following years.
Many medical expenses are unpredictable, which can bring the “use it or lose it” rule in to play from time to time. Orthodontic treatment, however, is nearly always planned for. This makes your FSA the perfect tool to utilize as part of your payment strategy for braces.
Let’s look at an example to see how this might work.
The actual treatment fee will vary depending on the specific orthodontic needs, but we will say that the total cost of braces is $5,000 in this example. And now let’s consider insurance coverage. Although there are variations, most insurances will cover between $1,000 and $2,000 for braces or other orthodontic treatment. In this example, let’s say that your insurance company provides a lifetime benefit of $1,500.
Here is the math so far.
$5,000 (total cost) – $1,500 (insurance coverage) = $3,500 (your total investment)
Although a $3,500 investment is a perfectly reasonable amount to pay for orthodontic treatment, passing up on an FSA could mean you are leaving significant tax savings on the table.
Let’s assume that you are in the 25% federal income tax bracket, and that your South Carolina income tax is 7%.
25% + 7% = 32%
If you contribute $2,600 to your FSA in 2017, using the full amount to pay for braces, and then use another $900 of your FSA for the same braces in 2018, you can calculate your tax savings in this way.
$2,600 + $900 = $3,500
$3,500 x .32 = $1,120
Side note: You could also split the FSA payments evenly between the two years at $1,750 a piece, or split it in any way you like so long as it adds up to $3,500. If you time the start of orthodontic treatment properly, you can even stretch the payments into three different “coverage periods.” This may be desirable if you want to use your FSA for other qualified medical expenses as well as for braces.
So instead of paying $5,000 for braces, after insurance and FSA savings, you are effectively paying $2,380.
Here is the math.
$5,000 (total cost) – $1,500 (insurance coverage) – $1,120 (FSA tax savings) = $2,380
And here is another way to look at it.
$1,120 (FSA tax savings) / $3,500 (your total investment) = 32%
In this example, the $1,120 tax savings effectively amounts to a 32% reduction in your total investment after insurance coverage is applied. This is equal to the amount you would have paid in federal and state income taxes had the funds not been contributed to your FSA for braces or another qualified medical expense.
Regardless of how you look at it, setting aside funds in your FSA can be a great way to reduce the effective cost of having braces for you or your child and investing in a life-changing smile!