Tax Tips
Trim Taxes with Flex Accounts
Cut next year’s taxes by signing up for a flexible spending account today.
By Mary Beth Franklin, Senior Editor, Kiplinger's Personal Finance
December 3, 2008
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Add this to your end-of-year to-do list: Sign up for your employer’s flexible spending account to pay for next year's child-care and medical bills with pre-tax dollars. You’ll be among a savvy minority. Although flex accounts are a valuable way to stretch dollars, fewer than one-quarter of eligible employees take advantage of them, according to a recent survey by Hewitt Associates.
Salary that goes into these reimbursement plans dodges federal income and Social Security taxes and, in most states, state income tax, too. Flex-account distributions are tax-free, and the full amount you allocate for the entire year is available immediately.
For example, if you put the maximum $5,000 into a plan to pay child-care bills that you have to pay anyway, 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-related expenses are tougher to predict, you can save big by paying for your out-of-pocket health-care costs with pre-tax dollars. That’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 ceiling on contributions to health-care flex accounts, employers often set dollar limits. Use our calculator to find out how much you should put into your flexible spending account.
And now you have an even better reason to fund a flex account. In the past, if you didn’t clean out your account by December 31, you forfeited the balance. But many employers now grant a two-and-a-half-month grace period beyond the traditional deadline. If your company is one of them and your current balance is not enough to pay for an anticipated expense, such as laser eye surgery, wait until January, when your 2009 contribution will be added to the remainder of your 2008 balance. Then you can cover the full cost with pre-tax dollars.
Finally, more employers are starting to offer another tax-advantaged option for out-of-pocket medical expenses: health savings accounts. HSAs, which must be paired with a high-deductible health insurance plan, have no use-it-or-lose-it provision. Unused funds roll over from year to year and you can take the money with you when you switch jobs or retire. Like flexible spending accounts, HSA funds are tax-deductible, grow tax-deferred and distributions are tax-free as long as you use them for medical expenses.
Reader Comments (4)
Posted by: Mike Sanderson at 12/03/2008 05:37:48 PM
You can save money but you will spend a lot of time trying to get your provider to actually pay the expenses. So if your time and aggravation tolerance are important to you, consider this carefully.
Posted by: Martin at 12/04/2008 12:20:50 AM
I agree with the previous poster, getting the plan...to actually pay for things can be a nightmare.
Posted by: K Roney at 12/04/2008 02:12:17 PM
I question the accuracy of the sentence in this article that the full amount you allocate for the entire year is available immediately...FOR DEPENDENT CARE expenses. With my plan, only HEALTH CARE expenses are available immediately, well, once my employer reports the amount in the new year. Dependent care expenses are available only after my employer makes my deposit in my FSA. I could spend the full amount in January, but I'd have to wait all year long to get the money reimbursed since my FSA deposits are spend over the calendar year. I imagine that is a rule with all plans and not just the one offered by my employer.
Posted by: Suzi at 12/05/2008 02:59:43 PM
I've used a flex plan for years, usually using it up by mid-summer to fall, and have never regretted it and the savings. It takes a little effort to submit health expenses, but the forms with my employer are now available online and expenses are reimbused within 3 weeks. If you are getting reimbused for your portion of a doctor bill, they usually send the check out of flex automatically after processing the ins pymt side of it. I had over-budgeted for my health this year, but after submitting OTC and mileage expenses, I have now used it up. K Roney is correct with the Dependent Care plans, you only receive the funds after your employer deposits them, so I do get a check coming all year even though I've "spent" the funds within a couple months. Also, a single parent can only put $2,500 in for Dependent Care.