A Flexible Spending Account (FSA) provides a simple way to increase spendable income. FSAs allow you to pay for expenses for medical care (such as out-of-pocket medical costs) or for dependent day care costs with gross (pretax) instead of net (after-tax) income. This leaves a smaller amount of income subject to taxation. When you pay less in income taxes your spendable income increases.
You save the income/withholding taxes (23% - 46%) on every expense you pay through the FSA, depending on your tax bracket. FSAs can save you thousands of dollars over the long term.
Health Care and Dependent Day Care FSAs
There are separate FSAs for health care expenses and dependent day care expenses. FSAs are authorized and regulated by section 125 and 129 of the Internal Revenue Code. Health care FSAs follow the definition of medical care as state in Code 213.
Annual Election Amount
In most cases, FSAs are funded through pretax salary deductions. Once you calculate how much out-of-pocket expenses you expect to have for health care and/or dependent day care costs over the plan year, you can elect to contribute this amount, before taxes, to your FSA. The annual amount (your election) is spread out evenly over the plan year by dividing it over the number of paychecks for the year. This fractional amount is deposited into your FSA with each paycheck.
NOTE: The Patient Protection and Affordable Care Act (PPACA) caps the maximum annual election under a health care FSA at $2,500 beginning on January 1, 2013. The maximum annual election for a dependent day care FSA will remain at $5,000.
FSAs run on a plan year which is a 12-month period in which you may elect a per paycheck amount or an annual election for the plan year’s time period. Please note your plan year dates and when you are eligible to participate in the plan as you can only be reimbursed for service dates that occurred in your plan year or after your eligibility date into the plan.
** Update 10/31/2013**
On October 31, the Department of Treasury (DOT) announced a major policy change to FSAs. The DOT modified the Healthcare FSA "Use It or Lose It" provision to allow carryover of FSA funds (up to $500) from one plan year to the next. This change must be adopted by the employer. Refer to your Summary Plan Description (SPD) for details on your employer’s plan.
Grace Periods & Run-Out Periods
Depending upon how your employer has set up their FSA program, you may or may not have a Grace Period or Run-Out Period. Refer to your Summary Plan Description (SPD) for details on your employer’s plan.
The Grace Period is a period of time commencing at the end of the plan year during which a participant can both incur and submit claims against the prior plan year. By law, the Grace Period can be up to two-and-one-half months after the end of the plan year (into the new plan year). The Run-Out Period is a period of time commencing at either the end of the plan year or at the end of the Grace Period, during which an employee may submit claims that have already been incurred during the plan year and Grace Period.
Calculating your Dependent Day Care Annual Election Amount
It is very important to conservatively estimate dependent day care expense amounts. IRS regulations state that funds left in your FSA at the end of the plan year and/or grace period cannot be given back to you.
The Dependent Day Care FSA provides significant tax savings if you pay for the care of a dependent in order to work. If you are married, both you and your spouse must be employed (volunteer work does not apply), attending school full-time or looking for work to be eligible.
For 2012 you may claim pre-tax expenses up to an annual maximum of $5,000 per married couple (or single filing head of household) or $2,500 for those filing single, non-head of household.
Depending upon your tax circumstances, participation in the dependent day care FSA may or may not produce a larger tax savings than the Federal Child Care Tax Credit. (We recommend you seek the advice of a tax advisor).
Calculating your Health Care FSA Annual Election Amount
Determine how much money
you and your family spend for out-of-pocket healthcare expenses during the plan year, the12-month period in which you may make an annual election (not necessarily the calendar year).
You must be aware of your plan year dates as you can be reimbursed only for service dates that occurred during your plan year. It is important you are aware of the service date, and the service date is in the plan year in which you are eligible.
Changing your Annual Election Amount
Your election to participate may only be made once a year and the amount may not be changed unless there is a change due to, and consistent with, a change in family status. A qualified change in family status must be reported within 30 days of the change and includes:
- Marriage, divorce, death of a spouse, legal separation or annulment;
- Change in the number of dependents, including birth, adoption, placement for adoption, court-documented change in custody arrangement or death of a dependent;
- Any of the following for you, your spouse or dependent: termination or commencement of employment, a strike or lockout, commencement or return from FMLA, or any change in employment status that affects eligibility for benefits;
- One of your dependents satisfies or ceases to satisfy the requirements for coverage due to change in age, student status, or similar circumstances;
- A change in daycare providers or rates charged by the provider (must not be a relative) which would be a significant increase or decrease.
Note: A rate or benefit change is not a qualified change in family status when the day care provider is a relative of the participant or a relative of the participant’s spouse.
When can I spend my FSA funds?
Dependent Day Care FSA: You may only withdraw up to the total of your deposits to date, but we encourage you to submit for the full amount charged and we will do the bookkeeping for you.
Health Care FSA: You may withdraw up to your annual election (the amount you elect at the beginning of the plan year) at any time.
What happens if I terminate employment or take a leave of absence during the plan year?
Your status as an active participant in the health care FSA ceases with your termination. After you terminate, funds remaining in the health care FSA may be paid out if the date of service for your eligible expenses occurred on or prior to your termination date. However under the Federal continuation laws (COBRA), the health care reimbursement account is considered a COBRA continuable plan. Therefore, if you have funds in your account and do not have sufficient eligible expenses incurred prior to the date of termination, you may elect to continue your participation in the plan through COBRA. You will be required to continue making your contributions on a monthly basis, after tax.
Your contributions to your dependent daycare FSA stop with your termination; however, you may continue to request reimbursement from your account for eligible expenses incurred through the remainder of the plan year until the funds in the account are depleted.
In the event of a Family Medical Leave of Absence (FMLA), you may accelerate your contributions in advance of the leave (pretax), continue your current contributions on an after-tax basis during the leave, or increase your per pay check contribution for the remainder of the plan year upon your return. You may continue to request reimbursement for eligible expenses during this period only if you had prepaid or contributed to your account while you were on leave. You may wait and request reimbursement upon your return to work if you are making up the contributions.