Flexible Savings Accounts (FSA) often create a love-hate relationship. FSA plans allow money to be withheld from payroll on a pre-tax basis for medical expenses, which can result in notable savings. The reasons many individuals dislike them is due to both tracking expenses and the “use-it-or-lose-it” rule. Let’s take a look at why FSA plans should become one of your most loved benefit plans.
- Big Tax Savings – Unlike retirement plan contributions, which are only free from income tax, FSA contributions are free from income AND payroll tax. For most people, that’s an additional 7.65% of tax savings. As an example, if you are in the 25% federal tax bracket and your state income tax rate is 5%, your tax savings would be almost 38%. If you contributed the maximum in 2015, that would be a direct savings of $961.
- Easier Administration – In the past, FSAs had forms for each purchase and the taxpayer would have to get reimbursed. Now that many plans offer a debit card, the plan provider handles much of the administrative burden. If you struggle to keep receipts for records, try taking a picture of your receipt and uploading it to a medical folder. By doing that, you can easily retrieve the receipt later if your provider asks for it.
- Broad Definition of Medical Expenses – Although non-prescription over-the-counter medicine is not eligible for FSA purchases, most other health related items are. You can claim expenses such as acupuncture, chiropractic care, and prescribed medical massage. For a more comprehensive list of covered expenses, see Publication 502.
- Rollover or Grace Period – In the past, the only option for unused dollars was to use the grace period, which allows taxpayers until March 15th of the following year to incur qualified medical expenses against the prior-year unused monies. Recent regulations now allow employers to offer a $500 rollover of unused funds instead. Make sure to check with your employer to see if they have adopted this new ruling.
In addition to a traditional FSA, Dependent Care FSA plans also offer the same tax savings for qualified child-care if the care enables you or your spouse to work. The maximum contribution is $5,000 per family. Even though there is a separate child-care tax credit, the savings from a dependent care benefit plan typically work out to be much larger than the tax credit.
Learn if your employer offers an FSA plan and understand what the grace period rules are. By taking advantage of this plan for expenses you are already occurring, you can significantly lower your tax burden without incurring additional expense items in your budget.