Flexible Spending Accounts: Are They for You?
NEW YORK ( MainStreet)For many employers, fall is open enrollment for "Flexible Spending Accounts" or FSAs.
If your employer offers you the opportunity to participate in a Flexible Spending Account, either for health care or dependent care, you should consider enrolling. You can realize substantial tax savings.
Participants in an employer-sponsored health or dependent care FSA can set aside a specific dollar amount from their salary each year to pay for medical or child-care expenses during the year. Employee contributions to an employer-provided Health Care FSA are limited to $2,500 per year. This amount will be indexed annually for inflation. The maximum amount you can set aside for a Dependent Care plan is $5,000.
The tax benefit from a Flexible Spending Account comes from the fact that employee contributions are considered "pre-tax" for federal and often state income tax and FICA (Social Security and Medicare) tax purposes. If your annual salary is $50,000 and you set aside, and spend, $2,500 in an FSA, the federal wages reported in Box 1 on your Form W-2, as well as the Social Security and Medicare wages, will be $47,500. If you are in the 25% bracket, this $2,500 will save you $816 in federal income and FICA tax, and maybe some state income tax as well.
Medical expenses are deductible as an Itemized Deduction on Schedule A only to the extent that they exceed 10% of AGI for a taxpayer under age 65. Medical expenses paid through a pre-tax Health Care FSA are fully deductible from gross income.
A pre-tax contribution to a Dependent Care FSA will generally provide a greater tax benefit than claiming the Child and Dependent Care Credit especially for those in the 25% and higher brackets. The maximum credit allowed is $600 for one qualifying child or $1,200 for more than one qualifying child.
The tax savings does not end there. Pre-tax employee contributions to an FSA will reduce Adjusted Gross Income and could increase a multitude of deductions and credits affected by AGI.
An FSA is a "use it or lose it" plan. If the amount of medical expenses or qualifying child-care costs paid by an employee-participant during the year is less than the amount that has been set aside in the plan, the employee loses the excess.
If Jane Doe has set aside $5,000 of her salary in her employer's dependent care FSA for 2013, but pays only $4,000 in qualifying child care expenses during the year, she loses $1,000 in wages! The $1,000 cannot be carried forward to the next plan year. So if you are a participant in a Dependent Care FSA and you currently have an unspent balance in your "account," make sure you spend that balance before year-end so you do not have to forfeit any of your salary.