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Research Desk: Do changes to flexible spending accounts hurt middle-class families?

By Dylan Matthews

ncgators asks:

A discussion broke out at lunch today about flex-spending accounts. In the new healthcare bill is an item reducing FSA limits to $2500. Of course the right-wing side of the table (most of my colleagues) complained at how the government is taxing them even more to help pay for the un-insured. But isn't it true that most "middle-income" (< $250k) families use these and they'd technically be the ones paying more (if even a little) in taxes?

An FSA is a flexible spending account, in this context a medical flexible spending account, which allows employees to set aside a portion of their earnings to pay for medical expenses not covered by an insurer. The funds are exempt from income or payroll tax but must be used by March 15 or the balance of the FSA is forfeited. Currently, there is no maximum contribution to FSAs.

The Affordable Care Act introduces a cap on FSA contributions, allowing only $2,500 a year starting in 2013. It also prohibits FSA holders from using the funds to pay for over-the-counter medication not prescribed by a doctor, and doubles the penalty -- from 10 percent to 20 percent -- for using the funds for non-medical purposes.

An analysis from Hewitt Associates finds these new rules probably won't affect most FSA users. For one thing, the average yearly contribution is $1,441, well under the new limit, with only 18 percent of FSA users currently spending over $2,500. Those who do, Hewitt finds, tend to make over $150,000 a year. The over-the-counter rules will likely have a minimal impact as well. Just 7 percent of FSA claims are for over-the-counter drugs, most of which will still be available under the new rules. And with only 20 percent of employees using a FSA, the percentage of Americans affected by the new rules will be rather small indeed.

It's worth noting that FSAs have a number of downsides even in this revised form. By requiring the funds be spent on health care, and spent within a year, they encourage unnecessary procedures and drive up medical costs. And they tend to help high-income people much more than lower- or middle-class workers. By exempting contributions from payroll taxes, FSAs reduce workers' total contributions to Social Security, and thus their later benefits. Their income tax benefits affect only those paying personal income taxes, which is to say middle- and upper-class earners, with upper-class taxpayers benefiting the most. Some, such as the Center for Budget and Policy Priorities, have taken these as reasons to eliminate FSAs altogether, or limit them much more severely than the Affordable Care Act does.

Dylan Matthews is a student at Harvard and a researcher at The Washington Post.

By Dylan Matthews  |  August 23, 2010; 12:30 PM ET
 
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Comments

The problem with funds being used for unnecessary procedures could have been dealt with by relaxing the "use it or lose it" rule to allow some percentage of unused funds to roll over the way cell phone minutes can.

It's hard to spin this as anything other than a tax increase for people with high out-of-pocket health care costs.

Posted by: tl_houston | August 23, 2010 1:02 PM | Report abuse

Those folks with heavy medical needs, from chronic diseases, disabilities, etc. are really being slammed by the increasing cost of health care. Deductibles and copays continue to increase and if you REALLY have medical needs, you are being heavily hit, even with insurance. It IS the middle class being hit - the rich can afford it anyway. With use or lose, those with continuing medical problems can at least attempt to plan ahead and have some fiscal help. The use of FSA cards have helped the aggrevation of using accounts and I only wish I could use them for all my medical needs and avoid all the paperwork. When you have heavy medical needs, you look for any way to help the out of pocket costs. Until reform can rein in costs, don't hit the families in the middle who need all the help they can get. Wait until you have a couple kids with asthma or disabilities and try paying for it all, even with health insurance!

Posted by: whytehs | August 23, 2010 1:25 PM | Report abuse

Those folks with heavy medical needs, from chronic diseases, disabilities, etc. are really being slammed by the increasing cost of health care. Deductibles and copays continue to increase and if you REALLY have medical needs, you are being heavily hit, even with insurance. It IS the middle class being hit - the rich can afford it anyway. With use or lose, those with continuing medical problems can at least attempt to plan ahead and have some fiscal help. The use of FSA cards have helped the aggrevation of using accounts and I only wish I could use them for all my medical needs and avoid all the paperwork. When you have heavy medical needs, you look for any way to help the out of pocket costs. Until reform can rein in costs, don't hit the families in the middle who need all the help they can get. Wait until you have a couple kids with asthma or disabilities and try paying for it all, even with health insurance!

Posted by: whytehs | August 23, 2010 1:26 PM | Report abuse

We should do away with all deductions and subsidies for health insurance and health care. However, so long as we persist in continuing the employer exclusion, equal treatment should be given to HSAs and MSAs, which are, after all, one of the few mechanisms in our current approach to health care that actually acquaint the consumer with the actual cost of their health care.

Posted by: bgmma50 | August 23, 2010 1:49 PM | Report abuse

whytehs, you clearly have never had an FSA if you think they are a way to "avoid all the paperwork." The only one who avoids paperwork when an FSA gets used is the provider. You must either submit your receipt for service and a form to receive back your own money from your account, or if you use an FSA debit card, you must submit to frequent audits by the card-issuer which require you to come up with documentation of your own -- and providers are generally not familiar with what constitutes valid documentation and will frequently provide you with documents that don't satisfy the FSA administrator, requiring second and third attempts to satisfy them.

I write this as a 10-year user of an FSA. I love the concept, and I love that it saves me money, but I work for every dime of it doing paperwork that would normally be done by my doctor, pharmacist and insurer. They are not a "free lunch."

Posted by: Rick00 | August 23, 2010 2:00 PM | Report abuse

The flip side to the use-or-lose-it rule is that an employee can spend the entire year's amount on day 1, in advance of actually funding the account. If someone spends all of the money in their FSA and then quits mid-year, the employer is on the hook for the difference.

Also, while there is no limit in law, an employer can set any limit it chooses, and many if not most set their limit at $2,500 or less.

Also, if the employer chooses, the regs do allow for a carryover of up to 2 1/2 months.

Posted by: biz5th | August 23, 2010 2:17 PM | Report abuse

Uh oh. I didn't realize this. It's going to hurt us a lot, as all three of us need expensive glasses and contacts (high prescriptions) and the associated medical visits to get them. We currently claim around 3k a year just on eye needs.

None left over for Tylenol.

Posted by: KathyF | August 23, 2010 3:02 PM | Report abuse

The PPACA eliminates a significant value of FSA's by prohibiting "FSA holders from using the funds to pay for over-the-counter medication not prescribed by a doctor".

Under the new rules, if your child needs an O-T-C analgesic, if you simply go to the pharmacy and pick up a bottle, you have to pay with post-tax dollars -- if you first go to a physician and get a prescription for the O-T-C analgesic, you can pay with pre-tax dollars. This is cost saving only for the federal government (which gains tax revenue), not for the consumer.

[Is it permissible to say Tylenol® rather than O-T-C analgesic?)

Posted by: rmgregory | August 23, 2010 3:21 PM | Report abuse

"Currently, there is no maximum contribution to FSAs." This is wrong, there is a limit of $5000 currently.

Also, these funds can be used for child care, which unlike many medical issues is at least predictable. I would imagine many people maxing out at $5000 are applying it to this end.

Finally, "those [who spend a lot thru the FSA] Hewitt finds, tend to make over $150,000 a year.... in this bracket additional dollars are not impacting social security, but you are saving ~35% of $5000 in taxes. (contra "FSAs reduce workers' total contributions to Social Security, and thus their later benefits")

you are dead right, FSAs help "high income" people more than low income. but where do we make the high-low cutoff? certainly well below $150,000.

Posted by: Polydoc1 | August 23, 2010 3:41 PM | Report abuse

It would make a lot more sense to get rid of the FSAs, and increase the individual income tax deduction to cover basic needs, as it used to do when first instituted. So, individuals would probably get a $20,000 income tax deduction to start off with, since it is hard to believe that most people an afford a simple lower-middle class life style with adequate food, shelter, clothing and medical care for less than that. If you have 4 individuals in your family, up to $80K would be untaxed income. THEN, and only then would you start taxing income, at a good rate, because then you would have excess income and would be able to afford the taxes. A lot of people rebel against taxes when they see 20% of their meager earnings disappearing, and they get precious little in return: poor police protection, poor health care, poor food supplies, and on and on and on. I understand the frustration, although I am glad to pay taxes.

We need a real economic overhaul, and we need to quit pretending that rich folks are really nice and sweet, instead of the predatory leeches they currently are.

Posted by: carolcarre | August 23, 2010 4:31 PM | Report abuse

The problem with removing the OTC drugs is that it becomes hard to spend those last few dollars. In a system where unused dollars are lost this is a pain. The perceived loss is probably greater then the actual loss but the perception of loss will cause people to use the system less.

Posted by: chrynoble | August 23, 2010 5:53 PM | Report abuse

Through my work with the Save Smart Spend Healthy campaign, I've found that with out-of-pocket health care costs expected to rise in 2011 and many consumers already cutting back on their health care due to budgetary constraints (see http://www.nytimes.com/2010/08/17/health/policy/17health.html?_r=2), flexible spending accounts are an important way for Americans to save money. The problem with capping contributions to $2,500 is that it hurts those who already have the highest health costs – as whytehs mentioned earlier. The OTC restriction, meanwhile, is a poorly-written provision that has the potential to drive up health care costs by sending individuals to their doctors more often for medications that they have the ability to purchase without a prescription. For more information on flexible spending accounts, visit www.savesmartspendhealthy.com.

Posted by: cgarlow | August 24, 2010 11:51 AM | Report abuse

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