Brace Yourself: The Benefits of Flexible Spending

If you have a child in need of braces, now might be the time to stuff a few thousand dollars into a flexible spending account. It could save you some big money, and this might be your last chance to do so.

The reason I bring this up is that, at many workplaces, it is now open enrollment period, the time of year when employees are given up to 30 days to make changes to employer-sponsored benefit plans.

At the same time, Congress could soon cut back the tax savings available to workers through the health care version of a flexible spending account. The health care reform bill recently approved by the Senate Finance Committee includes a provision that would cap the amount workers can contribute to health care flexible spending account at $2,500 a year, beginning in the 2011 tax year with no annual adjustment for inflation.

This means that 2010 could be the last year a middle-class family facing a $5,000 bill for braces -- or some other big medical expense -- could offset that cost with nearly $1,400 in tax savings in a single year. The proposed $2,500 cap on annual flexible spending account contributions for health care expenses would reduce the tax savings under this scenario to about $700.

For a family with three children, the lost tax savings could amount to about $2,100 in just a few years.

I don't mean to devote too much attention to crooked teeth. Braces are just a way to illustrate the benefits of flexible spending plans and point out how these advantages may be cut back in the current health care debate.

Thousands in Savings

There's more at stake than just the cosmetic. Thousands of dollars are at stake for families whose members struggle with chronic diseases, or whose medical insurance carries high deductibles and large out-of-pocket expenses. These are cases where a health care flexible spending account can make a big difference to the family budget.

A flexible spending account is a popular benefit option offered by many employers that allows participants to avoid taxation on money spent for health care and dependent care expenses. At the time of hiring, or during the annual open enrollment period, employees may elect to set aside a portion of their pay for a given year into a flexible spending account.

Whatever money is directed into the account is free from all taxes, including income, Social Security and Medicare. This means after-tax pay is higher.

Flexible Spending Accounts on the Edge

Employees must be careful about how much they set aside as any funds left over at the end of the plan year are forfeited. In many cases, there is a grace period of up to two and half months after the plan year to spend the remaining funds, but ultimately it's a use-it-or-lose-it mechanism.

When an employee incurs a qualified expense, he or she can seek reimbursement from the flexible spending account, or, in some cases, use a debit card linked to the account to pay up front for the expense. Accounts for health care expenses are maintained separately from dependent care spending accounts, and rules for the two types of accounts vary slightly.

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