Workplace benefits not only provide you and your family with much-needed services, some of them also can help cut your federal tax bill. One of the most popular benefits is a flexible spending account, often referred to as an FSA.
Companies typically offer 2 types of spending accounts, a dependent care FSA or a medical account.
With a dependent care FSA, an employee sets aside money to help pay for costs associated with care for the kids while Mom and Dad work. Covered services typically include nursery school for young children, after-school programs for older kids and day camp during the summer. Dependent care FSA money, however, can help pay the costs of any caregiver providing services while you’re at work, such as a home health aide looking after a disabled spouse.
Even more workers opt for a health FSA, in which they can set aside money to pay for routine items such as health insurance copays, uninsured treatments such as vision care or even over-the-counter drug purchases.
In both cases, the money is taken out through regular, equal payroll deductions. Even better, all FSA deductions come out of a worker’s paycheck on a pretax basis. That means less of your earnings are subject to tax.
As helpful as these accounts are, they have 1 big drawback: the use-it-or-lose-it requirement that costs workers millions of dollars each year. The law requires workers to spend FSA contributions by a certain date or forfeit them.
Claims deadline extended
When FSAs were first implemented, the accounts’ use-or-lose date was the end of the workplace benefit year, which in most cases is Dec. 31. In recent years, however, the IRS, which oversees the accounts because of the tax benefits, has made 2 FSA rule modifications to give workers some relief here.
First, health FSA participants now are allowed to make claims against their accounts for up to 2 months and 15 days after the end of their benefit year. This grace period means employees on a calendar benefit year now can use their prior-year medical account contributions for expenses incurred as late as March 15 of the following year.
Or companies have a 2nd FSA expansion option. Employers can allow their workers to roll up to $500 in unspent medical account funds into the next benefit year. Medical spending account owners are likely to benefit most from the change, but the rule also applies to dependent care accounts. The reality is, however, that workers rarely have excess dependent care account money at the end of the benefit year.
However, both of those modifications are optional and at the employer’s discretion. Check with your company to find out if it offers either of them so you know exactly by when you must use your health FSA money.
FSA contribution limit
While health FSA money can be a major benefit, it is not unlimited.
Under Affordable Care Act rules, the most any worker can put into a medical account is $2,550.
The cap on annual contributions to a dependent care account is $5,000. The dependent FSA limit applies to the whole family, meaning that even if both parents have access to flexible care accounts, their combined contributions cannot exceed $5,000.
“I suppose the IRS emphasized the medical side because that’s where people are more likely to have dollars left at the end of the year,” says Bob D. Scharin, senior tax analyst from the Tax & Accounting business of Thomson Reuters in New York. “I figure that people who use the dependent care benefit have probably already used up all of the funds in that account by the year’s end.”
Prescriptions now required
The health care law that now limits medical FSA contributions also affects which items can be paid for with the account funds.
FSA owners have had to get a prescription for most over-the-counter medicines or drugs in order for those purchases to be reimbursed. This includes pain relievers, cold medicines, antacids and allergy medications.
However, this new rule does not apply to reimbursements for the cost of insulin, which will continue to be permitted even if the medication is purchased without a prescription.
A preapproved benefits ‘loan’
One FSA benefit, however, remains. You 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 from your paycheck. 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 had only $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. On the plan’s books, your account will show a deficit that you will “pay off” each month until it’s zeroed out and you start accruing reimbursement money again.
Just make sure you know your company’s policy if you leave your job before you refill your FSA account. You could see any amount due taken out of your last paycheck.
Use it or lose it … later
While the option to give employees more time to use FSA money is welcome, it doesn’t change the use-it-or-lose-it component. It just means the possibility of wasting FSA money will simply be deferred. After the 2 1/2-month extension, any unused money will be forfeited as before.
So before signing up for an FSA, carefully review your personal and family medical needs. A quick check of last year’s medical costs is a good place to start.
“The biggest challenge for me is figuring out what my health care expenses are going to be from year to year,” says Beverly Molnar, who uses a dependent care spending account offered by her university employer. “Sometimes the health care expenses aren’t quite as predictable as the child care costs.”
Molnar remembers a time she did overestimate her medical expenses and faced the possibility of losing almost $1,000 left in the account. “The only thing that saved me was that my husband went into the hospital unexpectedly for surgery,” says Molnar. She didn’t use her account funds for his medical expenses (he has his own FSA); most of her excess FSA that year went toward Molnar’s costs of staying at a nearby hotel while her husband recovered.
Molnar says she knows her FSA saves her some tax money — she signed up at the urging of her tax preparer — but she hasn’t figured out exactly how much. But the account also has a side benefit. “It helps me budget a little better for health care, to keep track of what I’m spending,” she says.
You also might get another way to make changes if you find you didn’t do such a good job figuring your FSA amounts. A major change in your life — marriage, divorce, birth of a child, reduction in work hours, or job loss or change by your spouse — will allow you to revise your FSA contributions.
But for most employees, those changes are rare. So take the time to make sure you maximize this valuable company benefit.