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Flexible Spending Accounts Offer Tax Savings

Flexible Spending Accounts Offer Tax Savings

Should You Reconsider the Often-Overlooked Benefit?

By Margaret Steen

Your employer may be offering you a way to cut your tax bill -- and if so, it's likely you are turning it down.  

More than 80 percent of large employers offer flexible spending accounts (FSAs) in which workers set aside pretax money to pay for medical expenses or dependent care. But according to Mercer Health & Benefits, only about 20 percent of eligible workers use the medical accounts, and just 7 percent use the dependent-care accounts.

"Some just don't think it's worth the trouble," said Christopher Renz, principal of Mercer Health & Benefits in San Francisco.

Flexible spending accounts aren't for everybody. But knowing how to use them could save you hundreds of dollars in taxes.

Medical Flex Accounts

To use a medical flexible spending account, you choose an amount at the beginning of the plan year to have withheld from your paychecks. The maximum amount you can have withheld is $2,500 starting on January 1, 2013. The money is taken out in installments each pay period, and the amount is subtracted from your pay before taxes are calculated.

The average amount people choose to have taken out is $1,420, according to a 2010 Mercer survey. For someone in the 28 percent federal tax bracket, that's a savings of more than $350.

Any time during the year, you can turn in receipts for medical expenses -- including glasses -- and be reimbursed. The key points to remember:

  • If you don't spend all the money by the end of the year, you lose it. Most employers allow a grace period in which to submit receipts after the plan year ends, said Robert W. Schulte, benefits marketing representative for Allegiance Benefit Plan Management in Missoula, Montana. But after that, you have no way to get the money back.
  • If you leave your job midyear and have received more in reimbursements than you've had taken out of your check so far, you don't have to pay the money back.

The hassle of figuring out what's covered and submitting receipts keeps many employees from enrolling despite the tax savings, said Laura Noble, president of the Cincinnati affiliate of the National Human Resources Association.

"If you have a good year, which everybody wants, healthwise, it's kind of detrimental because now you've got this money sitting there and you've not spent it," she said.

Dependent-Care Flex Accounts

Dependent-care flexible spending accounts work basically like the medical accounts, except the money goes to pay a daycare provider. The maximum amount you can put into a dependent-care FSA is $5,000.

However, with dependent-care accounts, you can get money back only after it's been taken out of your paycheck. This means you have to live with a smaller paycheck and pay your daycare provider before you can get reimbursed.

Other important details: The care-giving arrangement has to be legal and reported to the IRS. The care has to be for your children under age 13, or dependents who are unable to care for themselves. Overnight camps and private elementary schools, for example, cannot be paid with the account's pretax dollars.

Finally, dependent-care accounts replace the federal childcare tax credit. Your employer can probably give you a worksheet to see which is better in your situation, but in general, higher earners are better off using the flexible spending account.

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