Flexible Spending Accounts, or FSAs, allow you to save pre-tax money for certain expenses, such as out-of-pocket medical expenses including co-payments and deductibles, child care and elder care. Instead of paying those expenses from your regular cash flow, you can withdraw money from your FSA to cover the bills.
Say you earn $30,000 and you save $2,000 to your FSA. You'll only be taxed on $28,000 of income. (It works the same way 401(k) contributions do.)
The challenge with FSAs is deciding how much money to set aside, because you have to choose an amount when you sign up for the plan without knowing precisely what you will actually spend during the coming year. To determine approximately how much you'll need, take a look at receipts from the previous year and estimate if your expenses in the coming year will be about the same.
But don't overestimate. It's better to save too little than too much in an FSA. These are "use it or lose it" plans -- if you don't spend the money, the excess is not returned to you.
Continued on page 4: Savings Accounts: Education Savings and Transportation Savings Accounts