Is a Limited Purpose FSA Worth It?

In some cases, it may be.

Healthcare can be a huge expense, no matter your age. And while it's a good idea to pad your savings account so you can cover medical bills, there are ways to save for healthcare in a tax-advantaged manner.

One option is to open a flexible spending account (FSA). An FSA lets you set aside money for healthcare using pre-tax dollars. Put $1,000 into an FSA, and that's $1,000 of income the IRS won't tax you on.

FSAs also require you to spend down your plan balance each year or risk losing that money. The good news, though, is that you can use the money in your FSA for a host of expenses, from copays for prescriptions to doctor's office visits.

But while FSAs are a great option for healthcare savings, there's an even more flexible account you might be eligible to contribute to -- a health savings account (HSA). To participate in an HSA, you need to be enrolled in a high-deductible health insurance plan. But from there, you can use the money in an HSA just like an FSA -- or leave that money alone and let it grow.

One benefit of HSAs is that you don't have to spend down your balance year after year. Rather, in addition to tax-free contributions, you can invest money in your HSA you aren't using right away and watch it grow tax free.

Now one thing you should know is that you can't have an HSA and an FSA at the same time. But there's one exception, and it's if your employer offers what's called a limited purpose FSA. These accounts can be used alongside HSAs. But does it pay to open one?

How a limited purpose FSA works

A limited purpose FSA allows you to set aside pre-tax dollars to pay for very specific healthcare expenses -- namely, vision and dental expenses. You can also use a limited purpose FSA to pay for regular medical expenses once your health insurance deductible has been met.

But remember, if you're opening a limited purpose FSA to use in conjunction with an HSA, it means you're enrolled in a health insurance plan with a pretty high deductible. And so you may not end up meeting your entire deductible within a year. As such, with a limited purpose FSA, you may really be limited to just vision and dental expenses. And so before you contribute to one of these accounts, you'll want to consider your costs carefully.

If you have dental insurance, it may be that your cleanings and routine or preventive care are covered 100% by your insurance. And so in that case, you may not have any out-of-pocket costs for dental care.

Similarly, if you don't wear glasses, you may not be able to use your limited purpose FSA for vision expenses. And even if you do wear glasses, if you're happy with yours and your prescription doesn't change, you may not need new ones, which means you may not have any vision expenses to use your limited purpose FSA for.

Be careful with a limited purpose FSA

All told, limited purpose FSAs give you more options for reaping tax savings in the course of setting money aside for healthcare. But these accounts really do live up to their name in that they limit you a lot.

Before you open one, make sure you're likely to need to use up your balance within a single plan year. It's not worth chasing tax savings if it puts you at risk of losing money.