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 in September 2003 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 services.
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 shoulder pain.
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
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
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"
Planning prevents wasted
Not everyone gets the needed appointment. Studies by benefits specialists
regularly show that employees typically forfeit more than $100 each
year in flexible medical accounts.
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
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.
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 tax-advantaged accounts.
-- Posted: May 20, 2004