Flexible spending accounts let you pay for eligible out-of-pocket health care before federal, state, and Social Security taxes are deducted from your paycheck. Taking advantage of them is a great idea.
Admit it: you probably spend more time comparison shopping online than reviewing your annual benefits enrollment materials. That's a big mistake, because the money you could save by choosing the right employee benefits package probably far exceeds any savings you could get on a big-screen TV.
For example, many people don't sign up for an extremely valuable benefit – flexible spending accounts (FSAs). If your employer offers them, FSAs let you pay for eligible out-of-pocket health care and/or dependent care expenses on a pre-tax basis – that is, before federal, state, and Social Security taxes are deducted from your paycheck. Using an FSA to cover expenses you would have paid for anyway reduces your taxable income by that amount, which in turn lowers your taxes.
Here's how it works: Say you earn $40,000 a year and are in a 25 percent tax bracket. If you contribute $1,000 to the health care FSA and $3,000 for dependent care, your taxable income would be $36,000 – about a $1,000 reduction in federal taxes alone, depending on your marital status, withholding deductions and other factors. (Use the calculator at www.dinkytown.net/java/Payroll125.html to evaluate your situation.)
Health Care FSAs let you pay for IRS-allowed medical expenses not covered by medical, dental, or vision insurance, including deductibles, copayments, orthodontia, glasses and contact lenses, prescriptions, chiropractic, and smoking cessation programs. Check IRS Publication 502 at www.irs.gov for a list of allowable expenses. Dependent Care FSAs let you use pre-tax dollars to pay for expenses related to care for your children, disabled spouse, parent, or other dependent incapable of self-care, including:
For some lower-income families, using the federal income tax dependent care tax credit is more advantageous than an FSA. So crunch the numbers or ask a tax expert which alternative is better for you. Just be aware that you cannot claim the same expenses under both tax breaks.
Your FSA contributions are deducted from paychecks throughout the year. As you incur eligible expenses, you submit receipts to the plan administrator for reimbursement. Also, many employers now offer prepaid health care cards, that let you draw on your account at the point of service to pay for qualified medical expenses, thereby eliminating the need to pay cash up front and submit reimbursement forms.
Keep in mind these FSA restrictions:
This article is intended to provide general information and should not be considered legal, tax, or financial advice. It's always a good idea to consult a tax or financial advisor for specific information on how certain laws apply to your situation and about your individual financial situation.