We all know that budgeting, saving, and investing are basic elements of sound financial planning, but sometimes opportunities are overlooked that can have a profound effect on a financial situation. Employer-provided benefits are a prime example. This week’s blog will dive into the details surrounding Flexible Spending Accounts.
What is a Flexible Spending Account (FSA)?
A FSA provides a tax-advantaged way to pay for eligible out-of-pocket healthcare expenses and/or work-related dependent day care expenses. Authorized by Internal Revenue Code Section 125, a FSA allows tax-payers to pay for eligible expenses with pre-tax dollars, thereby lowering their taxable income. Employers have the option of offering a healthcare spending account, a dependent day care account, or both.
- A healthcare spending account allows you to set aside pre-tax dollars to pay for qualifying out-of-pocket health care, dental, vision, or hearing expenses. Eligible expenses are defined as those that are not covered by existing insurance plans and can include deductibles, coinsurance, co-pays, and certain over-the-counter (OTC) expenses.
- A dependent day care spending account allows you to allocate pre-tax dollars to pay for child or adult day care expenses so that family members can continue to work. Eligible expenses include day care, before-and-after school programs, nursery school or preschool, and summer day camp.
How does it work?
The owner of the FSA designates an annual amount to contribute to the account. To determine the amount, start by reviewing prior years’ expenses to help plan for predictable costs. Your employer then deducts a prorated amount, which is pre-tax, from paychecks throughout year and deposits the money into the FSA. When approved medical expenses occur, the money to pay for them is already saved in the account. It is important to note that you must elect to participate in an FSA each year.
Is there a limit to how much I can contribute?
Yes. The maximum allowed by the IRS is $2,550 for a FSA and $5,000 for the dependent care FSA for 2015. However, the minimum and maximum amount for your specific plan is set by your employer, as long as it complies with the IRS maximum. Even though contributions are being made throughout the year by way of payroll deduction, your entire balance is available at the beginning of the benefit period. As an added benefit, each spouse can contribute the maximum $2,550 to a healthcare FSA account, however, the household maximum for the dependent care FSA is set at $5,000.
What happens to funds in the account at the end of the plan year?
Any funds left in your account at the end of the year are forfeited. If your employer has elected to include a “grace period,” you will be allowed an additional 2 ½ months after the end of your plan year to use your FSA funds. A recent rule modification from the Internal Revenue Service (IRS) now allows FSA holders to roll over up to $500 of savings for use in the following year. Your employer cannot implement a grace period and the $500 rollover rule, so check the plan documents in order to know your options. Avoid forfeitures by carefully reviewing prior years’ out-of-pocket expenses to estimate next year’s spending.
To learn more about FSAs, ask your employer for a copy of your Summary Plan Description and the current open enrollment materials. A few minutes of your time filling out a simple form can add up to big savings for you next year. Don’t miss out! If your company does not offer FSAs, we are available to review other ways to save taxes on health and dependent care-related expenses.
Andrea L. Blackwelder, CFP®, ChFC and Joseph D. Clemens, CFP®, EA are the founders and partners of Wisdom Wealth Strategies. Their shared passion is simple: to bring financial empowerment, understanding, and peace-of mind to people who wish to improve their financial future, build wealth for their families, and achieve financial independence. Click here to find out more about how you can work with Wisdom Wealth Strategies.
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