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 28% 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 in her flexible benefits account, and her actual expenses are $5,000. What is her cost of underestimating the expenses?
b. Rosa puts $5,000 in her flexible benefits account, and her actual expenses are only $4,000. What is her cost of overestimating her expenses?
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?