Here’s How To Fix The Flexible Savings Account

The Flexible Savings Account (more commonly called the Flexible Spending Account, or FSA) has the potential to be a great financial tool for every American.  Flexible Savings Accounts are usually set up through a cafeteria plan by American employers.  The FSA allows employees to deduct money from their paycheck, tax-free, into a special account that can be used to pay qualified expenses, usually either medical or childcare expenses.  Since no tax is owed on funds diverted into these accounts, the federal government is in part subsidizing these medical and childcare expenses.

The Flexible Savings Account’s Fatal Flaw

The ability to use pre-tax funds to cover health expenses is a great boon for employees; however, like always there is a catch.  Contributions to FSA’s are use-it-or-lose-it.  If you accidentally contribute more than you end up needing, the company gets the money back.  That’s right, this rule basically makes it legal for a company to take back money it has already paid you, predictably leading to all manner of last-minute scrambling to spend leftover FSA contributions, an effect I doubt congress had in mind when it created the plans.

Some healthcare costs, such as yearly physicals, semi-annual teeth cleanings, diapers and baby formula, etc are predictable and easy to plan for.  Others, such as broken bones and automobile accidents, are practically impossible to predict.  And so employees are left with a dilemma.  Should they contribute only what they know for a fact they will use by the end of the year and risk missing out on paying for life’s unexpected health problems with pre-tax money?  Or should they contribute a surplus and then scramble to spend the extra funds on things they don’t really need when the anticipated emergency never materializes (or worst of all, lose the money entirely)?

How To Fix The Flexible Savings Account

The solution to this problem is simple and obvious:  take the employer out of the equation entirely and have the IRS take care of it.  Simply set a yearly maximum and allow families to deduct qualifying health expenses up to that amount.  Cheaters will be kept in line by the same mechanism currently in force, namely, the audit.  After a few years the IRS will have ample data to construct a detailed statistical model of normal taxpayer behavior, and obvious abusers will be easily caught.  As with any deduction, the taxpayer will be responsible for keeping receipts and detailed transaction records dating back at least several years.  This way, consumers get a break on their medical expenses without employers being put to unnecessary expense.