Recently my wife and I just renewed our medical flexible spending account. As silly as it may sound, we’re pretty happy to see that extra $50 to $100 in our checking account every two weeks. Even though we’ve always used one of these plans through her employer, I’m always surprised when I talk to other couples and find out just how many people DON’T use them. Or even know they exist!
Most married couples or families can attest to the fact that there never seems to be any shortage of medical or daycare bills to pay! This is why taking advantage of a flexible spending account can help you and your money design. So read on and find out how an FSA works and how it can put a little extra money in your pockets on these types of expenses.
What is a Flexible Spending Account?
If you spend a decent amount of money on medical bills or daycare, then you might be pleased to know that the U.S. government has a program setup to help you with these expenses. It’s a special type of fund called the flexible spending account or FSA for short.
There are lots of types of FSA’s, but the two most popular ones are the medical and dependent care plans. Basically, if your employer offers an FSA via their cafeteria plan options (something your Human Relations officer would know), then that can translate into a tax break for you. Here’s how:
• You elect an amount for your flexible spending account. For example, let’s say you elect to put $5,000 in for dependent care and medical expenses.
• Just like a 401k, money is taken out of your paycheck before taxes are taken. Over 26 pays, that means $192.31 will be taken out of your income each paycheck and placed in your FSA.
• Throughout the year, when you have medical or daycare payments, you request a reimbursement for those expenses. The money from the FSA account is used to pay you back!
• So the benefit? THIS MONEY IS NEVER TAXED! That means more money in your pocket!
The annual maximum that you can contribute is $2,500 for the medical FSA and $5,000 for the dependent care FSA.
How the FSA Works:
Suppose you make $60,000 per year:
• $60,000 gross income after 25% taxes = $45,000 net income
Under normal conditions, you’d simply use that $45,000 to pay for daycare and medical expenses, as well as everything else like your mortgage, car, utilities, etc.
Now suppose you have a flexible spending account setup in the amount of $5,000:
• $60,000 gross income – $5,000 FSA = $55,000 gross income remaining.
• $55,000 gross income after 25% taxes = $41,250 net income
• BUT, you will eventually get back your $5,000 from your FSA throughout the year in reimbursements for medical and daycare expenses.
• Therefore, $41,250 + $5,000 = $46,250 actual income
• That’s a difference of $1,250 in your favor!
Remember – where did that extra $1,250 come from? From not having to pay taxes on the money you contributed to your FSA!
Another Way to Look at a FSA:
Suppose you’re looking at $10,000 in daycare bills this year. I remember I could have paid my mortgage twice with my daycare bill!
What if I told you that out of that $10,000 you have to pay, we could take $3,750 of it and turn it into $5,000? Here’s how:
• $3,750 in normal income / (1 – 25% tax rate) = $5,000 in gross income = $5,000 in an FSA
The Bad News About FSA’s:
Of course there had to be a catch! The bad news with a flexible spending plan is that it’s on a “use it or lose it” system. In other words, if you elect to fund your FSA with $5,000 BUT you only spend $4,000 in expenses, then you LOSE your $1,000. This is mean to deter people from maxing these accounts out and dodging taxes. So if you do choose to setup one of these accounts, talk about a realistic number you think you will spend and pick a number carefully. The last thing you want to do is lose money that belongs to you!
Unfortunately, the only way to sign up for one of these types of accounts is if your employer offers them. You can’t setup these accounts yourself. So if you’re interested, please talk to whoever handles Human Resources at your work and see if this is something they participate in. Obviously, this can be a nice financial break for families looking to stretch their dollars. So if your employer doesn’t offer them, print off this post and persuade them! I believe your employer also gets a tax break in the process!
Readers – Who out there participates in a flexible spending account? Who just found out what one is? For my readers in other countries, do they offer anything similar?
Image Credit: Microsoft Clip Art