Question

Rosa's employer has instituted a flexible benefits program. Rosa will use the plan to pay for her daughter's dental expenses and other medical expenses that are not covered by health insurance. Rosa is in the 24% marginal tax bracket and estimates that the medical and dental expenses not covered by health insurance will be within the range of $4,000 to $5,000. Her employer's plan permits her to set aside as much as $5,000 in the flexible benefits account. Rosa does not itemize her deductions, a. Rosa puts $4,000 into her flexible benefits account, and her actual expenses are $5,000. What is her cost of underestimating the expenses? b. Rosa puts $5,000 into her flexible benefits account, and her actual expenses are only $4,000. What is her cost of overestimating her expenses? (Assume this is a "use or lose" plan). c. What is Rosa's cost of underfunding as compared with the cost of overfunding the flexible benefits account? d. Does your answer in part (c) suggest that Rosa should fund the account closer to the low end or to the high end of her estimates?

Answer 1

Answer:

a)

Rosa's money in Flexible Benefits Accounts=$4000

Rosa's Acutal Expense= $5000

Hence, Underestimated Expenses=Actual Expenes-Amount in Flexible Benefits Account

=$5000-$4000=$1000

Hence Cost of Underestimating Expenses=Underestimated expense*Marginal tax Bracket

=$1000*24%=$240

b)

Rosa's money in Flexible Benefits Accounts=$5000

Rosa's Acutal Expense= $4000

Hence, Overestimated Expenses=Amount in Flexible Benefits Account-Actual Expenes

=$5000-$4000=$1000

Hence Cost of Overestimating Expenses= Overestimated Expenses*(1-Marginal tax Bracket)

=$1000*(1-24%)=$760

c)

Rosa's cost of underfunding as compared with the cost of overfunding the flexible benefits account=

cost of underfunding expenses=240=240/1000*100=2.4%

cost of overestimating expenses=760=760/1000*100=7.6%

Hence we can say that while comparing the above costs underfunding will be the better option.

d)

Yes, my answer in part (c) suggest Rosa to fund the account closer to low end of her estimates.