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  5. Flexible Spending Accounts: A Once-A-Year Tax Break

Flexible Spending Accounts: A Once-A-Year Tax Break

Updated for Tax Year 2020 / July 22, 2021 03:28 PM


OVERVIEW

No health insurance policy covers everything, and that's where Flexible Spending Accounts (FSAs) come in. FSAs are basically bank accounts reserved to pay for your out-of-pocket health care costs. Of course, anyone can put aside money to cover health expenses, but what makes an FSA special is that you don't have to pay taxes on the money you put into it.


For information on the third coronavirus relief package, please visit our “American Rescue Plan: What Does it Mean for You and a Third Stimulus Check” blog post.


 

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Flexible spending account basics

An FSA is only available as part of an employee benefit package, so if your company offers FSAs, taking advantage of it could prove to be very rewarding. These accounts allow you to use pretax dollars to pay out-of-pocket medical expenses.

You can use the money to pay for medical copayments and deductibles, as well as certain other covered medical and dental expenses.

For example, you can use FSA funds to buy:

  • Prescription medications
  • Over-the-counter medicines
  • Medical supplies like bandages
  • Medical equipment like crutches and blood-testing kits

Funding a flexible spending account

Get your FSA started by enrolling with your employer's benefits office and determining how much you want to put into the fund.

  • The maximum amount you can put into an FSA in 2020 is $2,750.

When you participate in this benefit, your employer deducts an amount from your paycheck every month to fund your FSA. Generally, the enrollment does not continue automatically from one year to the next, so remember to re-up if you want to continue this benefit.

Tax savings for flexible spending accounts

Since the money used to fund your FSA is pretax—taken from your paycheck before taxes are deducted—you save whatever percentage you would have paid on that money in federal taxes.

Let's say that you earn $50,000 a year. If you sign up for the FSA benefit and contribute $2,000 into an FSA account, if your tax rate is 30%, you would have a benefit of $600.

Use it or lose it

On the other hand, you don't want to think of the FSA as a savings account. It is a medical benefit intended to finance your annual out-of-pocket medical expenses. You may lose whatever amount is left unspent in the account at the end of the year.

The use-it-or-lose-it rule is not carved in stone, however. The Internal Revenue Service (IRS) offers employers the option to allow employees until March 15 of the following year to use FSA funds from the previous year.

The IRS also permits employers to let their employees rollover up to $500 in unspent FSA money into the following year. These are not rules, but options available to employers, so check your company's policies.

The Consolidated Appropriations Act (CAA) was signed into law on December 27, 2020 as a stimulus measure to provide relief to those affected by the pandemic. For tax years 2020 and 2021, the CAA allows employers to provide a grace period of up to 12 months into to following plan year for carrying over unused healthcare and dependent care FSA balances.

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