Flexible Spending Accounts (FSA), TRUE savings Based on Effective Tax Rate, *not* Marginal Rate, rig

So everywhere I look, I see the interwebs telling me that I will save approximately 30 cents on the dollar when I use my FSA.  That is based on the assumption that my tax bracket is 30%.

However, even if I'm in the 30% bracket, I certainly pay less than that in income tax.  My effective tax rate on income is closer to 10%.  That's because I'm only 8 years into a 30 year mortgage and pay mega-interest that is tax deductible, and I have two kids.  So in my case, I'm not saving 30 cents on the dollar for my FSA, I'm saving closer to just 10% right?  I mean, I guess the FSA dollars avoid both the income tax as well as social security and medicare, so maybe that increases the value of using FSA dollars, but it still wouldn't get me up to saving 30 cents on the dollar.

I think that "You'll save 30% on healthcare costs!!" line is bunch of baloney.

Am I thinking about this right? 

Comments

  • SherlockSherlock SuperUser ✭✭✭✭✭
    edited December 2018
    You should be accounting for your deductions when you determine your tax bracket.  If you are in a 30% tax bracket, you are paying a 30% tax on your marginal income so you do effectively save 30 cents on the dollar by avoiding the tax.  

    If you paid an effective tax rate of only 10%, that doesn't mean the last dollar you earn isn't taxed at a higher rate.
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  • James JJames J Member
    edited December 2018
    So let’s say I put $2,000 into my FSA last year. Let’s say my income tax bracket was 30% , and with all the deductions and credits my effective rate was 10%.



    If had NOT put that $2k into the FSA, how much more in tax would I have paid?



    I think I would have paid an additional $200 in income tax, or 10% of the $2,000. That’s not right?
  • SherlockSherlock SuperUser ✭✭✭✭✭
    edited December 2018
    James J said:

    So let’s say I put $2,000 into my FSA last year. Let’s say my income tax bracket was 30% , and with all the deductions and credits my effective rate was 10%.



    If had NOT put that $2k into the FSA, how much more in tax would I have paid?



    I think I would have paid an additional $200 in income tax, or 10% of the $2,000. That’s not right?

    If you are actually in the 30% tax bracket, you would have paid an additional $600 in taxes if you had NOT put that $2k into the FSA.
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  • James JJames J Member
    edited December 2018
    James J said:

    So let’s say I put $2,000 into my FSA last year. Let’s say my income tax bracket was 30% , and with all the deductions and credits my effective rate was 10%.



    If had NOT put that $2k into the FSA, how much more in tax would I have paid?



    I think I would have paid an additional $200 in income tax, or 10% of the $2,000. That’s not right?

    Even though my effective tax rate is only 10%?


    My effective tax rate is only 10%, so that’s really all I’m paying on my income, regardless of my marginal rate. So why would I pay 30% tax on that $2,000? (I’m assuming that additional $2,000 has no effect on bumping up either my effective or marginal tax rates. )
  • SherlockSherlock SuperUser ✭✭✭✭✭
    edited December 2018
    James J said:

    So let’s say I put $2,000 into my FSA last year. Let’s say my income tax bracket was 30% , and with all the deductions and credits my effective rate was 10%.



    If had NOT put that $2k into the FSA, how much more in tax would I have paid?



    I think I would have paid an additional $200 in income tax, or 10% of the $2,000. That’s not right?

    Yes.  Even though your effective rate is only 10%.

    If the marginal rate is 30%, you pay 30% on the additional income.

    Perhaps this will help: https://www.fool.com/taxes/2017/04/08/effective-tax-rate-vs-marginal-tax-bracket-what-yo.aspx
    Quicken user since 1997 
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  • James JJames J Member
    edited December 2018
    James J said:

    So let’s say I put $2,000 into my FSA last year. Let’s say my income tax bracket was 30% , and with all the deductions and credits my effective rate was 10%.



    If had NOT put that $2k into the FSA, how much more in tax would I have paid?



    I think I would have paid an additional $200 in income tax, or 10% of the $2,000. That’s not right?

    This is partly why I'm not completely sure I understand.  Check out this article from the same site, that says, with emphasis added by me, "Your ultimate savings, therefore, will depend on the amount you opt to contribute coupled with your effective tax rate."
    https://www.fool.com/retirement/2017/12/10/2018-fsa-changes-the-latest-on-flexible-spending-a.aspx


    So the article above seems to be saying, in my example, I'll save 10% of the $2,000.  Because 10% is my effective tax rate. 
  • SherlockSherlock SuperUser ✭✭✭✭✭
    edited December 2018
    James J said:

    So let’s say I put $2,000 into my FSA last year. Let’s say my income tax bracket was 30% , and with all the deductions and credits my effective rate was 10%.



    If had NOT put that $2k into the FSA, how much more in tax would I have paid?



    I think I would have paid an additional $200 in income tax, or 10% of the $2,000. That’s not right?

    Maurie Backman should have read Matthew Frankel's article before she wrote her article.  She should replace effective with marginal.
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  • James JJames J Member
    edited December 2018
    I think I see what you're saying, but I' having trouble making it jive with reality as I see it.  Maybe I'm asking the wrong question or using the wrong terms . . .

    I can see on my 2017 1040, that my effective tax rate was, actually, about 5% (to use an easy number).  My tax bracket was at 25%.  Let's say I earned $100,000, again just to use easy numbers.  I used an FSA with $2,000.

    So in 2017, I paid $5,000 of income tax.  

    If I had not used the FSA in 2017, my total tax bill would have been closer to $5,500?

    I'm having a hard time understanding how my effective tax rate is only 5%, but if I happen to take this additional $2,000 after tax, then suddenly the tax is 25%.  When I happen to earn more, for example if I get a bonus, I just don't think my income tax increases that much. . .

    (Actually, it blows my mind that my effective tax rate is so much lower than my marginal rate. How the heck is it so low?)
  • SherlockSherlock SuperUser ✭✭✭✭✭
    edited December 2018
    James J said:

    I think I see what you're saying, but I' having trouble making it jive with reality as I see it.  Maybe I'm asking the wrong question or using the wrong terms . . .

    I can see on my 2017 1040, that my effective tax rate was, actually, about 5% (to use an easy number).  My tax bracket was at 25%.  Let's say I earned $100,000, again just to use easy numbers.  I used an FSA with $2,000.

    So in 2017, I paid $5,000 of income tax.  

    If I had not used the FSA in 2017, my total tax bill would have been closer to $5,500?

    I'm having a hard time understanding how my effective tax rate is only 5%, but if I happen to take this additional $2,000 after tax, then suddenly the tax is 25%.  When I happen to earn more, for example if I get a bonus, I just don't think my income tax increases that much. . .

    (Actually, it blows my mind that my effective tax rate is so much lower than my marginal rate. How the heck is it so low?)

    I can see on my 2017 1040, that my effective tax rate was, actually, about 5% (to use an easy number).  My tax bracket was at 25%.  Let's say I earned $100,000, again just to use easy numbers.  I used an FSA with $2,000.

    So in 2017, I paid $5,000 of income tax.
       
    If I had not used the FSA in 2017, my total tax bill would have been closer to $5,500? 
    Correct.

    I'm having a hard time understanding how my effective tax rate is only 5%, but if I happen to take this additional $2,000 after tax, then suddenly the tax is 25%.  When I happen to earn more, for example if I get a bonus, I just don't think my income tax increases that much. . .

    (Actually, it blows my mind that my effective tax rate is so much lower than my marginal rate. How the heck is it so low?)

    Let's assume your taxable income is $100,000. you're married filing jointly, and using the table shown in https://www.fool.com/taxes/2017/04/08/effective-tax-rate-vs-marginal-tax-bracket-what-yo.asp

    Your tax bracket would be 25% and your effective tax on the taxable income would be 16.4775%    

    The tax on $100000 is calculated as follows:  $18650 x 10% + ($75,900 - $18650) x 15% + ($100000 - $75900) x 25% = $16477.50

    If your adjusted gross income was $329,550, the effective tax on the adjusted gross income would be 5%.
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  • ANONIEM PERSOONANONIEM PERSOON Member ✭✭
    edited December 2018
    The use of marginal rates is correct for the vast majority of personal finance decisions.

    See https://www.bogleheads.org/wiki/Marginal_tax_rate and https://www.kitces.com/blog/understanding-marginal-tax-rate-vs-effective-tax-rate-and-when-to-use-ea... for details.


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