Flexible spending accounts take
bite out of tax bill
Flexible spending accounts offer employees a great way to reduce their taxable
income while at the same time paying for medical or child-care expenses they know
they'll encounter during the year.
Uncle Sam has made the popular employee benefit even more attractive.
The Treasury Department and Internal Revenue Service announced Sept. 3 that
over-the-counter drugs can be paid for with flexible spending account money.
Previously, account holders were limited to paying for prescription-only purchases.
"Since many prescription drugs have moved to the over-the-counter
market, this action today makes paying for them a little bit easier to swallow,"
said Treasury Secretary John Snow in making the announcement.
Deducting your headaches
Consumers generally were pleased when drugs that once required a doctor's authorization
became available on drug and grocery store shelves -- until they realized that
their work-provided health plans no longer helped pay for the medications. In
many cases, the over-the-counter drug was less expensive than its prescription
predecessor, but the patient ended up paying more because he had to cover the
full price and not just a nominal insurance copayment. Now the account funds
can cover that excess.
The change in the account rules should make them even more attractive
to workers whose companies offer them as part of their overall benefits program.
Workers put money in these special accounts pretax; that is, it comes out before
taxes are deducted so you don't have to pay taxes on it.
This means Uncle Sam gets less of your dough in taxes, and
the actual reduction in your paycheck will be less than the amount you set aside.
For example, a $200 contribution may reduce your paycheck by only $180 because
a smaller amount of taxes is withheld.
An added way to meet costs
When you sign up, generally through a regular payroll contribution, your boss
puts the amount you select into a personal account for you to use to pay for
medical expenses or dependent care costs not covered by insurance.
Employers may offer a medical account, dependent care account
or both. Each category is separate, so if you want to cover both, you have to
let your boss know you want two accounts.
The major appeal of medical accounts, in addition to the
tax benefits, is added versatility in obtaining and paying for health-related
You can, and should, use the money to pay for doctor co-payments,
medications or insurance deductibles that otherwise would come out of your pocket.
But you also can spend it on many medical services that don't require prior
physician approval, or that may not be covered by your company health plan.
This means you could use the account to pay for those chiropractic
treatments -- not allowed by your insurance -- that finally relieved your chronic
With a dependent care account, pretax money can be used
to help pay the costs of any caregiver providing services while you're at work.
This includes the nursery school for kids or the home health aide looking after
a disabled spouse.
A pre-approved benefits 'loan'
You also can get to the money even before it's in your account.
Say you elected to put $2,400 in your medical spending account,
with $200 a month coming from each of your 12 paychecks that year. In early
March your son fell off his bike and, in addition to breaking his arm, all his
expensive orthodontia had to be redone. When all the damage was added up, you
faced $950 in deductibles not covered by your health insurance.
Although you only had $400 in your account when the accident
occurred, federal guidelines allow you to submit your out-of-pocket expenses
immediately for repayment. This way, you get cash now against the total amount
you pledged to pay into the account.
Use it or lose it
There are a couple of catches to flexible accounts.
The major drawback is the system's use-it-or-lose-it design.
The IRS says any flexible account funds must be used to pay for treatments provided
before the plan year's end or you lose the money. Since most companies operate
on a calendar year when it comes to benefits, if you leave any money past Dec.
31, it's lost cash.
While the money itself doesn't have to be disbursed before
Dec. 31 -- the IRS allows a 90-day period into the next year for the bills to
be submitted for payment -- the treatment must be within the same calendar year
as the contributions. If an employer is on a fiscal year rather than a calendar
year, the deadline date for treatment is the last day of the final fiscal month,
with the 90-day payout period following that.
This requirement prompts a mad December dash to medical
offices, especially optometrists and dentists. Here the insistent refrain of
patients declaring "it's got to be done this month" is almost as common
as "The Christmas Song" on Muzak.
Planning prevents wasted accounts
Not everyone gets the needed appointment. Studies by benefits specialists regularly
show that employees typically forfeit more than $100 each year in flexible medical
This means you shouldn't decide how much to contribute without
first carefully reviewing your personal and family medical needs. A quick review
of last year's medical costs is a good place to start.
Businesses generally use the leftover money to help defray
administrative costs of the program. In some instances, employers allow workers
to designate a charity to which the unused funds are sent.
Other account drawbacks
There also is limited opportunity to refine your spending plan participation.
Unless there is a major change in your life -- marriage,
divorce, birth of a child, reduction in work hours, or job loss or change by
your spouse -- you're stuck with putting in what you chose during the enrollment
period. This means that even if your mother comes to live with you and now takes
care of the kids, you still must make your regular dependent care contributions.
Only a life-change event will get you into a flexible spending
account plan if you miss the sign-up deadline. For most companies, the deadline
is Dec. 31. But some operate on a fiscal, rather than calendar year, so check
with your benefits manager for your business' benefits deadline.
'$5,000 is a joke'
Then there's the limit on the amount of money you can contribute.
The IRS limits the annual contribution for dependent care
accounts to $5,000. This is a family limit, meaning
that even if both parents have access to flexible care accounts, their combined
contributions cannot exceed $5,000.
Employees regularly contribute the maximum amount to the
care accounts, according to Linda Wurzelbacher of B.A.S.I.C.,
an employee benefits administration firm.
"In fact, employees are always telling us $5,000 is
a joke," she said. "It's not an amount that kept up with the times.
"Anybody with kids will tell you that they easily exceed
this amount in day care in a year."
No limit on medical money
On the medical side, there are no hard and fast contribution amount rules.
The IRS leaves it to employers to decide how much workers can contribute to
these flexible accounts.
Wurzelbacher explains that the IRS views the reimbursement
provided by medical flexible accounts as a self-insured health plan. Because
an employee can get to flexible account money even before it is fully paid in,
the business has to carry any early reimbursements. If the employee quits before
the money is paid back, the employer takes the loss.
Because of that risk, Wurzelbacher said, Congress and the
IRS have left it up to each business owner to individually determine what his
risk will be when it comes to flexible medical account limits.
There are periodic
rumblings on Capitol Hill about the need to raise the dependent care contribution
limit, as well as to make the medical portion even more flexible. Legislation
is regularly introduced that would let employees roll unused medical contributions
over into the next year.
But until those proposals
become law, workers must determine just how much they want to contribute annually
to their flexible spending accounts. Careful computations mean no wasted plan
money. It does require some extra work, but most employees agree that the time
spent is a small price to pay in exchange for accessible expense cash in these
-- Posted: April 6, 2004