Flexible spending accounts (FSA) allow employees to set aside a portion of their earnings to be used for approved medical expenses. The major advantage of an FSA is that the funds are not subject to payroll taxes and reduce an employee’s taxable income. For example, if the employee is in a 30% tax bracket and funds an FSA with $ 1,000, the person reduces his or her tax burden by $ 300. The disadvantages of an FSA are:
• An employee must decide how much of his or her earnings to deposit in the account at the beginning of the year.
• The funds can only be used for specific medical expenses.
• Any unused funds at the end of the year are lost to the employee.
Beth has estimated that the probabilities of experiencing medical expenses of $ 1,000, $ 1,500, $ 2,000, and $ 2,500 during the upcoming year are 0.10, 0.20, 0.30, and 0.40 respectively.
a. Choose the amount of earnings Beth should deposit in the FSA using this probability data.
b. What is the most that Beth should pay for additional information about what her medical expenses will be?