Flexible Spending Accounts for Medical and Dependent Care

Does your employer offer flexible spending accounts? Do you take advantage of this benefit?

If you answered “yes” to the first question but “no” to the second, you might be losing hundreds of dollars, depending on your income-tax bracket, every year.

What Are Flexible Spending Accounts?

Too many employees do not understand the benefits of flexible spending accounts, better known by the acronym FSA.

Such accounts allow employees to set aside money from their regular paychecks on a pre-tax basis to pay for out-of-pocket medical or dependent care expenses.

That might sound confusing, but here’s how it works: Every pay period, your employer deducts a set amount of money from your paycheck. You then use that money to pay for medical or dependent-care expenses that your regular health insurance will not cover. For instance, you might need to lose weight to stave off diabetes or hypertension. So you could use the money in your flexible spending account to pay for enrollment in a weight-loss program.

The benefit of this is obvious: You will be saving up money for health expenses regularly. You then won’t face a significant financial shock if you need to pay potentially pricey out-of-pocket healthcare expenses.

However, there’s an even more significant financial benefit: The dollars you stow away in your flexible spending account are considered pre-tax dollars. That means that they reduce the amount of income you will have to report to the IRS every year, thus reducing the amount of income taxes you must pay each year. For example, if you earn $40,000 a year and put $2,000 into a flexible spending account, the gross income you must report to the IRS falls to $38,000. Depending on the size of your tax rate, that could result in significant tax savings.

The Internal Revenue Service limits the amount you can deposit into an FSA each year. In 2022, FSAs will be limited to $2,850 per year, a $100 increase from last year. However, contribution limits expect to be raised annually based on the inflation rate. However, even with restrictions, the savings are still meaningful to most employees.

Types

Companies that offer FSAs tend to provide two different kinds: those set aside for healthcare expenses and those created for dependent care.

It is important to note that dependent-care accounts are not just for your children. Dependent-care accounts can be used for any of your dependents, including your elderly parents, if you are taking care of them.

How can you use your FSA money? A recent story by CNBC does a good job listing some options. For example, if you suffer a disability, you can use FSA money to pay for renovations to make your home more accessible. If you need to lose weight to battle a doctor-diagnosed medical problem, you can use FSA money to sign up for weight-loss programs. You can also use the funds in your account to pay for gasoline or tolls when you use your car for medical reasons.

If you have a dependent-care FSA, you can use the money in it to pay for a nursery school for your children, nannies, or adult daycare.

Use it or Lose it

Flexible spending accounts are not perfect, however. For example, they come with a provision that requires you to spend all of the money deposited in your FSA account before the end of the year or risk losing any unspent funds.

The “use-it-or-lose-it” rule has always been one of the most significant downsides to saving in these plans. Some plans provide a grace period to let you use the money by March 15th of the following year, but the “lose it” rule kicks in after that date.

In response to many consumers’ issues in losing such unspent funds, the U.S. Treasury Department amended FSA rules in 2013. The changes permitted employers to offer plans that would allow employees to roll over up to $500 from their current plan year account for the next plan year.

However, such changes come at the employer’s discretion, and many haven’t implemented the new option. Many companies have decided to maintain the March 15th grace period instead of the rollover provision as IRS rules force them to choose one option or the other. Check with your plan administrator to see what your company offers.

FSAs, then, are as flexible as their name suggests. Unfortunately, however, their availability from employers is not as widespread as many would like. According to the U.S. Bureau of Labor Statistics, only 43 percent of private industry workers have access to FSAs, while 71 percent of state and local government workers have access.

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