The spiraling costs of healthcare have caused many employers to offer more than basic health insurance as a means of recruiting employees. Flexible Savings Accounts have become popular companion vehicles that employees can use to pay for medical expenses not covered by health insurance.
Flexible Savings Accounts, or FSAs, resemble qualified retirement plans in some key respects. The employer deducts an amount of the employee’s choosing out of his paycheck on a pretax basis and places it inside the account. Starting in 2012, the maximum possible contribution by employees is $2,500 per year. This limit effectively reduces the cost of out-of-pocket medical expenses for employees by exempting all qualified plan distributions from taxation. However, the money that is placed in these plans must be used by the end of the year or else it is forfeited. Expenses that qualify for tax-free distributions used to be generally the same as those that qualify for the medical expense deduction on the Schedule A of the 1040, but recent legislation has restricted qualified expenses to anything prescribed by a doctor. However, such things as psychological counseling, dental care and vision care are also covered.
Getting the Most out of your FSA
It is important to know the rules of these accounts and plan ahead in order to maximize tax savings and minimize losses from them. Start by assessing your past medical expenses and compare them to your anticipated future expenditures. If your past medical expenses exceeded your FSA contributions, then you might as well increase your contributions if they are going to remain constant for the foreseeable future. Of course, if you have major upcoming expenses that you did not have before, then you should obviously raise your contribution level accordingly. Similarly, If you had a major operation that required substantial out-of-pocket payments that cured your condition, then obviously you shouldn’t plan on having the same level of expenses in the future.
While you will obviously want to avoid any forfeiture if at all possible, don’t be afraid to make your contributions, because the tax savings can still leave you coming out ahead as long as what’s left isn’t substantial. If you contribute $2,000 into your FSA and only use $1,800 for expenses, then you most likely will still be better off than if you had only contributed $1,500 and used it all. (Of course, this is not always the case; if you are not sure about where you are in this regard, don’t hesitate to consult your tax advisor.) Just remember that you get the deduction for your contributions regardless of whether or not you are able to use the funds in your flexible savings accounts. For more information about Flexible Savings Accounts, download Pub. 969 off of the IRS website at www.irs.gov or consult your financial advisor or human resources department.