Tax Tips
Trim Taxes with Flex Accounts
If you typically under-fund your flexible spending account -- or skip participating altogether because of concerns about the use-it-or-lose-it rule -- fear no more.
By Mary Beth Franklin, Senior Editor, Kiplinger's Personal Finance
December 18, 2006
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'Tis the season for millions of employees to sign up for flexible spending accounts to pay for next year's childcare and medical bills with pre-tax dollars. In the past, if you didn't clean out your account by December 31, you forfeited any unused funds.
Now, the IRS allows a 2½-month grace period to spend your flex funds until the following March 15 -- if your employer allows it.
Salary that goes into these reimbursement plans dodges federal income and social security taxes and, in most states, state income tax, too. Put the maximum $5,000 into a plan to pay childcare bills that you have to pay anyway, and you would save nearly $2,000 in taxes (assuming a 25% federal bracket, 5% state bracket and 7.65% Social Security tax.) A dependent-care account also can be used to pay for help for an elderly parent or other family member who lives with you.
Although health care expenses are harder to predict, you can save big by paying for your out-of-pocket health care costs with pre-tax dollars. It's particularly important now as more employers are asking their employees to share the burden of rising health insurance expenses by paying higher deductibles and co-pays. Although the law sets no ceilings on contributions to healthcare FSAs, employers often set dollar limits.
One of the key advantages of a health care FSA is the full amount you allocate for the year is available immediately. For example, if you contribute $100 a month ($1,200 a year) to a health care FSA for 2007 and then spend $500 on dental work in January that is not covered by insurance, you can get a reimbursement for the full $500 in January even though you have not yet contributed that much to an FSA.
Use our calculator to find out how much you should put in your flexible spending account. And check with your employer to seek if your plan allows the extra 2½-month grace period. If it does and your current balance is not enough to pay for an anticipated expense, like new glasses, wait until January when your 2007 contribution will be added to the balance. Then you can cover the full cost with pre-tax dollars.
