Flex Spending: Worth the Cost?

Four reasons to stop using this employee benefit in its current form, and how to fix the broken system.

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Flex spending, an employee benefit that enables people to pay for health care and other eligible costs with pre-tax dollars, seems, on the surface, like a wonderful idea. Users can save a lot of money by paying for certain expenses, from co-payments to deductibles to contact lenses, before taxes. That means someone with a marginal tax rate of 28 percent can save $56 on a $200 hospital bill.

[See 8 Painless Ways to Save Money.]

But there are a lot of problems with flex spending in practice. First, there’s the paperwork. Most workplaces use an outside company to process flex spending dollars for them. So employees collect their receipts, fill out forms, and fax the information over to the third-party provider. Then, if all goes smoothly, they get a check in the mail a couple weeks later. (Some employers offer debit cards to avoid some, but not all, of this hassle.)

But often all does not go smoothly: Addresses are incorrect, leading to delays and cancelled checks. Claims are incorrectly rejected. Or the employee does not have as much money in the flex spending account as she believed. (All three of these problems have happened to me.) That means phone calls, time spent on hold, and more faxing.

That brings up the second main problem with flex spending: The time it wastes. Filling out the paperwork, following up when necessary, depositing the checks that arrive in the mail… getting one $100 reimbursement can take as much as an hour or, if there are complications, even two or more.

Thirdly, there’s the money that gets wasted. How many people forget about their flex spending accounts until it’s too late? The “use it or lose it” policy means that even if people have set aside pre-tax dollars from their paychecks, they never see that money if they fail to file the paperwork on time. Money also goes to waste if receipts and mailed checks are lost or never deposited.

Lastly, there’s the fairness issue. Only certain kinds of employers offer flex spending programs at all. Some 85 percent of large companies have the benefit; estimates are harder to find for smaller companies and small businesses. Certain employees, such as office workers, are more likely to have the time to file the paperwork at their workplace. And people with the highest incomes benefit the most from this program, since they face the highest tax rates.

[For more money-saving tips, visit the U.S. News Alpha Consumer blog.]

To be sure, flex spending offers great benefits to employees who take advantage of it. Pinyo Bhulipongsanon, owner of the Moolanomy Personal Finance Blog, says that he collects all of his receipts in one folder and then files the paperwork once a month or every two months. Each time, it takes between 15 and 30 minutes. “Considering the amount of tax savings we get, it’s definitely worth the time spent,” he says.

That’s why flex spending has become something of a sacred cow among personal finance experts, who constantly urge people to file their paperwork and reap the rewards. But why not make the system easier to use, instead of putting the entire onus on employees? Since only one in five employees eligible for flex spending programs actually take advantage of them, something is clearly wrong.

Here’s what needs to happen for flex spending to become useful: The system should be paperless. We should be able to fill out all necessary forms online, or, better yet, health care providers should be able to forward our information with a click of a button while we’re at our appointments. There should be no “use it or lose it” system; instead, we should be able to pay with our pre-tax dollars on an as-needed basis. And instead of being based on the tax rates, all workers should be eligible for a certain percentage—say 20 percent—refund on their health care spending. Otherwise, the program will continue to be unfairly tilted in favor of higher-earners.

The days of flex spending, in its current form, should be numbered. It’s a broken system.

Kimberly Palmer is the author of the new book Generation Earn: The Young Professional’s Guide to Spending, Investing, and Giving Back.