Changes to Pre-tax Medical Spending Plans

Elaine E. Bedel

By: Elaine E. Bedel - President , Bedel Financial Consulting

Category: Personal Finance

If you use a Flexible Spending Account (FSA) or Health Savings Account (HSA) to pay your out-of-pocket medical costs with pre-tax dollars, you need to read this article. The new healthcare reform law reduces the use of these funds, limits the contribution amount, and increases penalties.

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The Patient Protection and Affordable Care Act that was signed into law by President Obama on March 23, 2010, will cost $940 billion over ten years. One way to fund the cost is to reduce the current benefits available through the medical spending accounts.

Flexible Spending Accounts

The Flexible Spending Account (FSA) is a popular option for paying medical expenses that are not covered by an employer-provided health insurance plan. As a participant, you contribute pre-tax dollars from each paycheck to the FSA. As medical costs are incurred that are not covered by the insurance plan, you request reimbursement from the FSA. Such costs include the deductible for the health insurance, co-pays, prescription and over-the-counter drugs, eyeglasses, contact solution, and other healthcare supplies.

The employer sets the limit on the amount that you can contribute each year. It is generally in the $2,500 to $5,000 range. However, if you do not use all the funds in the account during the calendar year, the funds are forfeited. Recent changes have allowed employers to provide a grace period through March of the following year to continue using the previous year’s FSA dollars on eligible expenses.

Changes due to health care reform bill:

1.Exclusion of Over-the-Counter Drugs. Starting January 1, 2011, unless your doctor specifically prescribes an over-the-counter drug, it will no longer be considered an eligible expense for reimbursement from your FSA. Since companies can be more restrictive with the reimbursement criteria, you may see your employer limit all drugstore purchases such as contact solution, bandages, and other healthcare supplies. This would eliminate the need to sort out which drugstore purchases are eligible and which are not. Your employer should provide more specific guidance prior to the end of this year. However, you will need to take this new limitation into account when you determine the amount to contribute to the FSA in 2011. Likewise, if you intend to stock-up on over-the-counter drugs to use up this year’s FSA account, you may want to do so prior to this new rule taking effect on January 1.

2. Contribution Amount Limited. Starting in 2013, the maximum amount that can be contributed to an FSA will be $2,500. For 2014 and future years, the maximum contribution amount will be increased for inflation. Since you may be eligible to contribute more dollars in 2011 and 2012, you may want to consider the higher-cost elective medical expenses that can be completed prior to 2013 when the limit applies. These expenses may include orthodontia work for yourself or children as well as Lasik surgery.

Health Savings Accounts

The Health Savings Account (HSA) is different from a flexible spending account. The HSA is only available if you choose to utilize a high deductible medical plan instead of the traditional medical plan. You contribute pre-tax dollars to the HSA, just as you do with the FSA, but any money remaining in the account at the end of a year rolls to the next. The HSA is used to pay for eligible medical expenses just like the FSA, but, unlike the FSA, you never lose the funds contributed to the HSA. The HSA funds can be carried into retirement and used for medical and long-term care expenses.

Changes due to health care reform bill:

1. Exclusion of Over-the-Counter Drugs. Just like the FSA, beginning January 1, 2011, HSA funds are not eligible to purchase an over-the-counter drug unless it is prescribed by your doctor.

2. Higher Penalty for Nonmedical Spending. Also beginning January 1, 2011, if funds are used from the HSA for nonmedical purposes, the funds become taxable plus a 20% tax penalty will be charged. This is double the current penalty of 10%.

At this time, there is no change noted in the bill regarding the contribution amounts to HSAs.

Benefit of Pre-Tax Spending

The ability to pay for medical expenses with pre-tax dollars is a real benefit. For example, without a medical FSA or HSA, to pay for $1,000 of medical expenses, you would need to earn $1,250. This assumes a low federal tax rate of 15% and a state and local rate of 5%. If you are subject to the highest federal tax rate of 35% with an additional state/local tax of 5%, you would have to earn $1,667 to pay the $1,000 medical bill.

The increase in income tax rates that is expected in 2011 coupled with the change in eligible expenses and contribution limits discussed above will result in higher out-of-pocket expenditures for your healthcare.


The FSA and HSA changes will generate additional revenue for the government, which is intended to help pay for the unfunded benefits provided by the health care reform bill. More details on the changes are expected from the federal Department of Health and Human Services who is administering the new law. However, since these changes may impact your decisions regarding how you fund and use your FSA or HSA accounts next year, you should contact your employer before year-end for additional information.

Elaine E. Bedel, CFP®, is president of Bedel Financial Consulting, Inc., a wealth management firm providing fee-only financial planning and investment management services for individuals, consulting services for corporate retirement plans, and investment advisory for institutions and endowments. She is the author of “Advice You Never Asked For…But wished you had!” available on For more information, visit their website at or email to

© 2010 Bedel Financial Consulting, Inc. All rights reserved.

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