Advantages & Disadvantages of Health Reimbursement Arrangements

Health reimbursement arrangements, sometimes known as flexible spending accounts, are a benefit offered by many companies in conjunction with standard health insurance. The object of flexible spending plans is to allow an employee to build a fund through payroll deductions that covers out-of-pocket medical expenses. There are many advantages to participating in a flexible spending account, but there are also a few downsides.

Flexible Spending Account Advantages

• Flexible spending account savings are automated. The plan is funded with payroll deductions removing any temptation for the employee to spend money allocated to health care on other things.

Deductions Done Before Taxes

• Contributions made to the flexible spending account are done before payroll taxes are calculated and deducted. This reduces the pay amount on which those taxes are calculated, resulting in reduced tax withholding. The employee receives a larger percentage of his or her pay each period.

Medical Expenses

• Many health insurance policies do not cover dental, vision, obstetrics, gynecology or psychiatric care. Flexible spending account funds may be used to pay for those expenses, as well as some alternative treatments such as those offered by Christian Science practitioners, acupuncturists and chiropractors. If the Internal Revenue Service considers payment for a treatment to be taken as a standard medical deduction the flexible spending account may be used to pay for it.

Expense Reimbursement

• If an employee incurs a large medical expense early in the fiscal year, he will be reimbursed by the flexible spending account up to the amount the employee pledged to contribute. This amounts to a no-interest loan to the employee.

Drawbacks of a Flexible Spending Account

• Unlike contributions made to health savings accounts which are allowed to accrue, contributions made to flexible spending accounts must be used during the fiscal year or they are forfeited to the plan administrator.

No Interest

• Funds paid into a flexible spending account are held in escrow and do not earn interest. The tax benefits afforded by participation may not outweigh the benefit to an employee of investing the same amount of money in a money market fund or savings account each pay period.

Tax Liability

• Because payroll deductions to flexible spending accounts are done pretax, the net taxes withheld from an employee's paycheck are reduced. If an employee does not also participate in a tax-deferral plan, such as a 401(k) or IRA, he may be under-withheld and owe state, federal and local taxes at the end of the fiscal year.

Anticipate Expenses

• At the beginning of each fiscal year, the employee is responsible for designating the amount to be withheld from his paycheck. This amount cannot be changed during the year unless there are changes to employment status or the employee's family situation. Over-withholding may result in the employee forfeiting money at the end of the year; under-withholding will result in the employee having to fund additional out of pocket expenses while still having money withheld weekly to fulfill his commitment.