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Tuesday, October 05, 2010

Reposted By Request: Flexible Spending Accounts

Below is an educational post I wrote in 2006 about Flexible Spending Accounts. Is it really almost that time again? I received a request to address the subject, so I am re-posting. Just a note that the new health care legislation will slash the health care FSA to $2,500 from amount employers normally allow, $5,000 although there is federal technically no limit.

Flexible Spending Accounts

The end of the calendar year is quickly approaching, and many employees are currently being asked if they want to fund a "Flexible Spending Account" (FSA). While the subject is relevant, I wanted to write a brief overview of these accounts, in addition to discussing their advantages and disadvantages.

In brief, the advantage of an FSA is the tax savings. The program allows an employee to put aside "pre-tax" money from earnings each pay period to help pay for two types of expenses:
1) Qualified Out-of-Pocket Health Care expenses and/or
2) Qualified Dependent Care expenses, i.e. childcare or adult dependent care expenses for qualified dependents that are necessary to allow you or your spouse to work, look for work (so long as you find a job and earn income), or attend school full-time.

An employee can put aside funds for one or both of these purposes, but funds must be designated separately for the entire calendar year. Both spouses can contribute the maximum amount allowed to their own Health Care FSA (HCFSA), however the amount allowed for the Dependent Care FSA (DCFSA) is limited per household.

Question: Just how much tax can you expect to save on your designated funds?
Answer: No less than 7.65% (FICA withholding that all employees are subject to) to upwards of 50%, although most will fall somewhere between 20 and 40%. To estimate your tax savings, add together your respective federal marginal tax bracket (ranges between zero and 35%), your respective state marginal tax (can range up to approx. 10%), and the 7.65% FICA withholdings.

Question: What Out-of-Pocket Health Care Costs qualify for coverage?
Answer: Basically all expenses except insurance premiums (e.g. dental and vision insurance) and items like over-the-counter vitamins. Of course, the list of allowable and unallowable expenses is a long and tedious read. But, before you go about designating your earnings, you should become familiar with it. [As of 2011, non-prescription, over-the-counter medicine and items like band aids will no longer qualify for reimbursement].

Question: What are the disadvantages?
Answer: The prime disadvantages are the following:
1) "Use it or Lose it" Whatever money is left in your account at the end of the Benefit Period (usually March of the following year, I believe) you forfeit for good. There are no refunds. This is a requirement of federal law.
2) If you are laid-off or leave your job without spending your account, it is gone forever.
3) The paperwork and record keeping. Proper documentation (receipts, bar codes on over the counter medications, etc) will need to be submitted with claims. Organization is key and those who lack time [or organizational skills] will suffer.
Update: Many companies do have paperless reimbursement for certain expenses like co-pays.

Question: Can I still receive a tax credit for my childcare on my 1040 Tax Return if I am using a DCFSA?
Answer: No and Yes. You cannot receive the tax credit for the amount you designated in your DCFSA, but the incremental excess amount that you spent beyond your DCFSA designation can be claimed. (It is a bit complicated, but here is an example: A household with two children can claim a credit on a percentage of $6000 in childcare costs or $3000 per child. If the family only designates $4000 to their DCFSA, they can claim a credit on the excess $2000.)
Note: The same goes for trying to deduct health care expenses above 7.5% of your adjusted from income on your Schedule A (Itemized tax deductions).

Question: Is it better to use the tax credit or the DCFSA?
Answer: It depends. Because a greater dependent care tax credit is offered to those with lower household incomes, some will benefit more from using the tax credit.

Question: Does my childcare provider need to be paid "over the table?"
Answer: Yes, yes, yes. Don't make your designation unless you know your provider is filing their taxes. You will need the Tax ID or Social Security number for your daycare provider or babysitter. Without this vital information, you will not be reimbursed. You also might want to make sure that your provider understands why you are asking for this information(!). [Regardless of your decision of whether or not you should use an FSA, your childcare provider should be paid legally].

Question: Is camp a qualified DCFSA expense? What about yeshiva tuition?
Answer: Day camp for a child 13 and under is a qualified expense. But, overnight camp is not, unless there is itemized billing for day services only! And, no tuition for an elementary school child does not qualify either. But, before and after-care services do if they are separately itemized.

Question: How much should I designate to my FSA?
Answer: Review your prior years expenses and estimate upcoming and new expenses [to come to a reasonable prediction of] future expenses, but be careful not to overestimate what you will spend because of the "Use it or Lose it" clause. Also, be very careful you only include qualifying expenses. You don't want to end up buying ridiculous amounts of over-the-counter drugs because you stand to lose a significant amount of money otherwise. [As of 2011, even if you are using 2010 funds within the grace period, you will no longer be able to buy over-the-counter drugs or a lifetime supply of band aids].

Disclaimer: Please do your more research if you have questions and read your enrollment forms carefully. This is a primer on the subject and is in no way a complete overview. FSAs are an excellent and legal way to make your income stretch further.

12 comments:

rosie said...

I rely on my FSA to pay for dental work after my $1500/year dental coverage is up. My understanding is that most dental insurance plans only cover $1500/year and a root canal with a crown is easily $2000. I wish I could find better dental coverage.

Anonymous said...

Please note that over-the-counter medications (Advil, Bengay) will not longer be FSA eligible starting 01/01/11.

conservative scifi said...

Orthonomics,

One important correction. I believe that the credit for childcare is for children "UNDER" 13, and does not include 13 year olds. So if your 12 year old started camp on June 25 and went for 4 weeks, turned 13 on July 25 and then went for four more weeks, only the first four weeks would fall within the credit. The second four weeks would not be eligible for the credit, since the child was already 13.

Anonymous said...

I sometimes wonder if my FSA is worth it. I send in itemized statements from my dentist/dr. etc showing what the services were and what was not covered by insurance, but the administrator rejects the claim and asks for more detail, so I am on the phone with the dr's office on hold asking for more paperwork, they send the wrong stuff and finally when I get the right documents I have to then go find and stand at a fax machine again, etc. Then, if we are lucky enough to be healthy and not use up everything we put into the FSA, I run out to the optomotrist on 12/30 or 12/31 to buy another pair of eyeglasses I don't need to use up the FSA.

tdr said...

I love my FSA! We have lots of OOP expenses and you can spend up to the yearly allocated amount even before the account is funded. We used ours up in 6 months. I was expecting to leave my job, but was told I wouldn't have to pay it back or anything.

You could potentially have a situation where you sign up for the FSA in November. Use the full amount by April. Get a new job in May and fully fund a NEW FSA for the next 6 months. And do it all legally.

Makes me giddy to think of it! :-)

I have had several of these and have never had difficulty getting reimbursed.

I had a situation where I didn't know if I would be reimbursed for a $1500 expense. I had paid the expense out of my FSA. I asked whether I was expected to reimburse the FSA if the insurance reimbursed. The answer was "That's a fuzzy area". (It was moot because we were not reimbursed.)

We have FSA charge cards to access the account directly for FSA expenses. You have to keep records in case of an audit, but I have never been audited.

For someone like me with lots of expenses, it is a no-brainer.

Anonymous said...

tdr:

While you correct that you don't need to pay back your FSA account if you spend more than you have in the account and then leave your job before the year ends but you are not able to fully fund 2 seperate FSAs in 1 year. You are limited to $5,000 in dependent care FSA and (beginning in 2011) $2,500 in medical FSA. So while you are able to fund 2 different employer plans in 1 year. The total cannot exceed the IRS limits of $5,000 and $2,500. Guess you'll have to find other things to make you giddy! :)

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JLan said...

" [As of 2011, non-prescription, over-the-counter medicine and items like band aids will no longer qualify for reimbursement]."

SL- all the lists I've seen so far suggest that band aids, contact lens solution, etc still qualify for reimbursement (ours for this year isn't out yet, but I just checked lists from 3 different FSA providers). The legislation apparently only involved OTC medicines, not other things.

"Then, if we are lucky enough to be healthy and not use up everything we put into the FSA, I run out to the optomotrist on 12/30 or 12/31 to buy another pair of eyeglasses I don't need to use up the FSA."

Anonymous- do you not have the ability to still use money from the previous year for 2 and a half months afterwards? If not, then you need to talk to your HR department (or whoever is doing the contracting); so long as you're signing up for the following year, they can legally set it up that way.

Abba's Rantings said...

i don't know if it's up to date, but the flyer i looked at from my wife's work says OTCs are covered if there is a presrciption for them.

who gets the money that is forfeited if you don't use it up? the employer? government? can someone explain to me the logic behind this. thanks.

Dave said...

They are forfeited to the employer, and may not be returned to the employee, although they may be used (if I recall correctly) for the benefit of all employees so long as there is no direct relationship between the amount an employee forfeited and the benefit received.

This isn't supposed to be a tax-free savings account.

Ariella said...

There are also HSA -- health savings accounts that do not rely on the employer's role. The money in an HSA account is not use it or lose it. You can roll it over, and you can also add to it. However, no many banks offer it, and many that do charge fees that could well wipe out your tax savings.

Anonymous said...

Just adding about the HSA comment that to use an HSA you need to have a high deductible health plan (typically $3,000 for family coverage but could be as low as the mid 2K to still qualify for high). I have both an HSA and a high deductible health plan through my employer and it just makes more sense. My employer pushes the plan strongly by providing significantly lower premiums to offset the higher deductible. The HSA is nice because you can max out on the contribution and not have to worry about using it all this year. In fact you can even use it to save for retirement health expenses.