What You Need to Know About FSAs

PHOTO: Money deducted for a medical flexible spending account can be used to pay for over-the-counter drugs among other things.

Workplace benefits not only provide you and your family with much-needed services, but some of them also can help cut your federal tax bill. One of the most popular benefits is a flexible spending account, often referred to as an FSA.

Companies typically offer two types of spending accounts. With a dependent-care FSA, an employee sets aside money to help pay costs typically associated with putting the kids in day care so mom and dad can work.

But even more workers opt for a medical FSA, in which they can set aside money to pay for routine items such as health insurance copays, uninsured treatments such as vision care or even over-the-counter drug purchases.

In both cases, the money is taken out through regular, equal payroll deductions. In both cases, the FSA deductions come out of a worker's paycheck on a pretax basis. That means less of your earnings are subject to tax.

As helpful as these accounts are, they have one big drawback: the use-it-or-lose-it requirement that costs workers millions of dollars each year. The law requires workers to spend FSA contributions by the end of the company's benefit year, which in most cases is Dec. 31. Any leftover account amount is forfeited.

Claims deadline extended

In recent years, however, workers have received some relief here. Spending-plan participants now are allowed to make claims against their accounts for up to two months and 15 days after the end of their benefit year. This grace period means employees on a calendar benefit year now can use their prior-year FSA contributions for expenses incurred as late as March 15 of the following year.

The one downside: This is allowed by the Internal Revenue Service, but companies aren't required to extend their FSA withdrawal periods. Check with your company's payroll or human resources department to see if you have some extra time to spend up your FSA account.

Medical-spending account owners are likely to benefit most from the change, but the rule also applies to dependent-care accounts. The reality is, however, that workers rarely have excess dependent-care-account money at the end of the benefit year.

Through 2012, individual companies set the limit on how much could be contributed to a medical account, but beginning in 2013 and going forward, a provision in the Affordable Care Act reduced the medical FSA limit to $2,500. There already is a firm federal limit of $5,000 on the annual contribution for dependent-care accounts. This is a family limit, meaning that even if both parents have access to flexible-care accounts, their combined contributions cannot exceed $5,000.

The pretax account money can be used to help pay the costs of any caregiver providing services while you're at work. This includes the nursery school for kids, a day camp during the summer or the home health aide looking after a disabled spouse.

"I suppose the IRS emphasized the medical side because that's where people are more likely to have dollars left at the end of the year," says Bob D. Scharin, senior tax analyst from the Tax & Accounting business of Thomson Reuters in New York. "I figure that people who use the dependent care benefit have probably already used up all of the funds in that account by the year's end."

Coordinating across benefit years

In addition to providing more time for claiming FSA reimbursements, the grace period also allows employees to coordinate two years of FSA contributions for maximum benefit, says Scharin.

For instance, suppose you have $200 left in your health care FSA as the year's end approaches. You plan to purchase new eyeglasses that cost $300. Under the old rules, Scharin points out, you would purchase the glasses in December, be reimbursed the $200 in your FSA and pay the $100 balance with your after-tax dollars.

Thanks to the carry-over rule, Scharin says you can wait until January to purchase your spectacles and pay the full $300 cost with pretax FSA dollars. The first $200 of the bill would come from last year's unused $200; the remaining $100 would come from the new year's FSA contributions.

If you annually put $1,000 in your spending account, this then would give you a $300 pair of new glasses, paid for with pretax dollars, and leave $900 in your FSA for the rest of the year.

Not so fast

But there is a catch.

"An employee is eligible for this extension only if his or her employer amends its FSA document to permit this grace period," Scharin says.

Employees of companies that make the extended FSA change certainly will welcome the added time to spend leftover money. Medical personnel also will likely greet such extensions warmly since it will give them more time during the traditional year-end holiday season. Previously, the end-of-year treatment requirement prompted a mad December dash to doctors, optometrists and dentists, where the insistent refrain of patients declaring, "It's got to be done this month," was almost as common as the Christmas songs playing on waiting-room sound systems.

Companies, however, might not be as sanguine because the change could mean costly changes associated with extra administration costs and employee notification and education efforts.

"It will be a little more hassle for the administrators," says Scharin. "The employer basically will be working with two plan years in the same year. But from the public relations side, companies will probably do it."

And just in case you have a medical and dependent-care FSA and were hoping to use the rule change to integrate the benefits, don't even think about it. You can't transfer excess from one account to another that's already been depleted. The IRS specifically warns that "unused amounts elected to pay or reimburse medical expenses in a health flexible spending arrangement may not be used to pay or reimburse dependent care or other expenses incurred during the grace period."

Prescriptions now required

The new health care law that now limits medical FSA contributions also affects which items can be paid for with the account funds.

Since Jan. 1, 2011, FSA owners have had to get a prescription for most over-the-counter medicines or drugs in order for those purchases to be reimbursed. This includes pain relievers, cold medicines, antacids and allergy medications.

However, this new rule does not apply to reimbursements for the cost of insulin, which will continue to be permitted even if the medication is purchased without a prescription.

A preapproved benefits 'loan'

One FSA benefit, however, remains. You can get to the money even before it's in your account.

Say you elected to put $2,400 in your medical spending account with $200 a month from your paycheck. In early March, your son fell off his bike and, in addition to breaking his arm, all his expensive orthodontia had to be redone. When all the damage was added up, you faced $950 in deductibles not covered by your health insurance.

Although you only had $400 in your account when the accident occurred, federal guidelines allow you to submit your out-of-pocket expenses immediately for repayment. This way, you get cash now against the total amount you pledged to pay into the account. On the plan's books, your account will show a deficit that you will "pay off" each month until it's zeroed out and you start accruing reimbursement money again.

Just make sure you know your company's policy if you leave your job before you refill your FSA account. You could see any amount due taken out of your last paycheck.

Use it or lose it ... later

While the option to give employees more time to use FSA money is welcome, it doesn't change the use-it-or-lose-it component. It just means the possibility of wasting FSA money will simply be deferred. After the two-and-a-half-month extension, any unused money will be forfeited as before.

So before signing up for an FSA, carefully review your personal and family medical needs. A quick check of last year's medical costs is a good place to start.

Read More on Bankrate: Obamacare for workers?

"The biggest challenge for me is figuring out what my health care expenses are going to be from year to year," says Beverly Molnar, who also takes advantage of a dependent-care spending account offered by her employer, Penn State University. "Sometimes the health care expenses aren't quite as predictable as the child care costs."

Molnar remembers a time she did overestimate her medical expenses and faced the possibility of losing almost $1,000 left in the account. "The only thing that saved me was that my husband went into the hospital unexpectedly for surgery," says Molnar. She didn't use her account funds for his medical expenses (he has his own FSA); most of her excess FSA that year went toward Molnar's costs of staying at a nearby hotel while her husband recovered.

Read more on Bankrate: 7 big health insurance changes from Obamacare

Molnar says she knows her FSA saves her some tax money -- she signed up at the urging of her tax preparer -- but she hasn't figured out exactly how much. But the account also has a side benefit. "It helps me budget a little better for health care, to keep track of what I'm spending," she says.

Read more on Bankrate: Are health insurance premiums tax-deductible?

You also might get another way to make changes if you find you didn't do such a good job figuring your FSA amounts. A major change in your life -- marriage, divorce, birth of a child, reduction in work hours or job loss or change by your spouse -- will allow you to revise your FSA contributions.

But for most employees, those changes are rare. So take the time to make sure you maximize this valuable company benefit.

Read this story on Bankrate.

This work is the opinion of the columnist and in no way reflects the opinion of ABC News.

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