Now that tax time is gone for another year, it’s time to think about tax planning for next year. If your employer offers a Flexible Spending Account (FSA) as one of your benefits, it can be a great way to save on taxes and ensure your medical Expenses and some of your childcare expenses are paid for with tax-free dollars.
What Is an FSA?
An FSA is an account that you set up through your employer if your employer offers it. It deducts Money from your paycheck before the money is taxed. The tax-free funds can be used to pay healthcare expenses such as doctor’s visits, deductibles, and prescription medication. It also pays for other health-related items, such as medical devices and prescription eyeglasses.
For parents, there are separate FSAs for childcare. This allows approved childcare expenses to be paid for out of tax-free money as well, up to the age of 13.
Benefits of an FSA
The primary benefit is the ability to pay medical expenses and childcare expenses with tax-free dollars. The money is never taxed, which saves you the amount of money you would have spent in taxes had you not set up an FSA. In other words, if you put $2,500 into your FSA account for the year, and your tax bracket is 25 percent, you save 25 percent of $2,500, or $625.
Some employers also contribute to FSAs. Be sure to check on whether your employer does or not.
Just be sure you don’t deduct any expenses you use or FSA to pay for, though. You cannot deduct tax-free money from your taxable income!
Drawbacks of an FSA
The primary drawback of an FSA is that you must use it or lose it. FSA savings must be used within a specific period, or you forfeit the money. The period is usually a year, although some employers allow you until March 15 of the following year or allow a rollover of $500 to the following year. As a result, FSA account holders have to carefully calculate what they think they will spend in a given year, or risk losing it.
Don’t be confused by the existence of Health Savings Accounts (HSAs). HSAs are also tax-free savings accounts for healthcare expenses. Those funds can accumulate throughout more than one year. FSAs cannot. Be sure to read your employer’s information carefully when choosing an FSA to ascertain the time frame in which you can use it.
How to Use FSAs
It’s a good idea to carefully review your past medical expenses and determine your likely expenses for the coming year. For some medical expenses, such as deductibles and ongoing prescriptions, this might be easy to estimate. Consider whether you will need anything this year, such as new prescription eyeglasses. It’s best to remain on the conservative side, so you don’t run the risk of losing FSA money.
If you’re going to have a childcare FSA, review past expenses. Call around to get an estimate of childcare expenses for next year.
In both cases, be sure to review what you can and can’t use your FSA to cover. You might find that you can’t use your FSA for acupuncture treatment and summer camp for your children after all.
FSAs can be excellent ways to save on taxes and fund your healthcare and childcare expenses. Be sure to put in no more than you expect to spend, though, so you don’t lose what you’ve set aside.
Scott Huntington is a writer from central Pennsylvania. He enjoys working on his home and garden with his wife and 2 kids. Follow him on Twitter @SMHuntington