Laura Rowley Money & Happiness

Andrea Petersen, a stay-at-home mother of three in California, is looking forward to open enrollment at her husband’s employer. For the first time, they plan to have money deducted from his paycheck pre-tax, and deposited into a flexible spending account (FSA) for medical expenses.

After using online budgeting software for two years, Petersen was able to track exactly how much they were spending on out-of-pocket health care costs, including treatment for their four-year-old’s asthma. “Based on that information, my husband and I were able to see the advantages in making changes to our health benefits plan,” she says.

For many employers, the fall season brings open enrollment -- that once-a-year opportunity for workers to change their benefit packages. But the vast majority of workers stick with the status quo: A recent MetLife survey of 1,000 people finds 77 percent of employees plan to maintain current work benefits, while 10 percent plan to increase them and 11 percent will cut back.

Many workers don’t make changes because they don’t recognize the upside of some benefit programs. A 2008 survey of human resources managers found only 21 percent believe their employees have a good understanding of the company’s benefits. One issue is that workers may get little guidance: 40 percent of the firms in the survey require workers to self-enroll to receive benefits.

Considering FSAs

Consider FSAs: More than 80 percent of employers with 500 or more workers offer FSAs for health and dependent care -- but just 22 percent of workers take advantage of health FSAs, and just 6 percent use dependent-care accounts for these costs, according to Mercer, the benefits consulting firm.

“I think when it comes to the FSA, people tend to not participate because they don’t understand how it works,” says Paul Fronstin, director of the health research program at the Employee Benefit Research Institute (EBRI). “Back in graduate school I was eligible for an FSA, but I didn’t know what it was, so I basically put the papers aside. If people are more educated about their benefits, they’ll take advantage of them.”

In a nutshell, an FSA allows workers to have money deducted from their paychecks pre-tax to pay for out-of-pocket health care expenses and child care (including summer camp). For example, someone in the 25 percent tax bracket who spends $2,000 a year on qualified medical expenses (or a qualifying day care center) would save that 25 percent -- or $500 -- if he sets aside the money in an FSA and has his employer reimburse him for those costs. (To determine how much you would save by using an FSA, check out this calculator.)

By law, the maximum contribution to a dependent care FSA is $5,000; there is no legal limit on health care FSAs, but employers typically limit them to $5,000 as well, Fronstin says. “A qualified medical expense pretty much covers everything except cosmetic surgery,” he says.

Providing Relief

The money can provide some relief for households faced with flat or declining incomes, and increasing deductibles and co-pays. In 2009, nearly half of companies froze salaries, up from just 2 percent in 2008, according to a survey of nearly 1,200 companies by Hewitt Associates. Separately, Hewitt found 65 percent of firms plan to shift more health costs to employees.

Part of the problem with FSAs is the need to predict health or child care costs a year in advance, because the accounts have a “use it or lose it” provision. Money set aside in the account that isn’t spent in 12 to 15 months (depending on the employer) is lost. A number of years ago, I wanted to enroll in my employer’s FSA to cover my oldest child’s pre-school costs. But I had to make the decision in October for the following fall, and I wouldn’t find out if she was accepted into the school until January.

“You can only build in so much knowledge,” Fronstin says. “For kids going back to day care, parents had to decide last October what to put in for now -- so there’s a little bit of uncertainty. There’s lots of uncertainty about how much health care you’re going to use, and people need to make reasonable guesstimates based on prior use.”  

Currently, health care FSAs can be used for over-the-counter drug expenses, so a worker who has money left over at the year’s end could presumably stock up on those basics. However, an amendment to the House version of the health care reform legislation would eliminate this.

Despite that potential change, you still might be better off participating and losing money than not participating at all, Fronstin suggests. For example, if you put $1,000 into an FSA and you are in the 25 percent tax bracket, you’ll save $250. At the end of the year, if you still have $100 left in the account, you’ll lose $100 but still come out $150 ahead in tax savings.

Petersen was able to predict her health care costs by tracking her expenses in a subscription budgeting system. She maintains separate “envelopes” for co-pays, prescriptions, over-the-counter drugs, dental, and chiropractic costs. “We have a small co-pay, but it all adds up over the course of a year,” she says, adding that bills related to her daughter’s asthma run “from a couple hundred dollars in a bad month to $30 in a good month.”

Workers heading into open enrollment should invest the time to plow through the benefits packet, Fronstin advises, adding that this year’s open enrollment season won’t reflect the current health care debate. “We are not actually seeing much change this year; most benefit decisions for this fall were made in April or May of 2008,” he explains. “We didn’t know who was going to bepresident, and the recession wasn’t obvious until that September. We’ve seen increases in deductibles and co-pays, but that trend was already in existence.”