Flexible Savings Accounts
This week’s Financial Friday comes on the heels of a budget deal, a closely averted government shutdown, and today is April 15- a day when you are reminded of how much of your hard-earned money goes to the Government for lord knows what. All of this is what inspires this week’s Financial Friday article on saving your money. If you missed the previous articles, click here to view Saving for your Child’s Education, Part I, Part II, and Part III.
If you are like most Americans, both parents work outside the home, resulting in hefty child care expenses. For two kids under the age of 5, we pay over $1900 a month! That is almost $24,000 a year and this is considered middle of the road. If you go for a higher end daycare/learning center, including fees and tuition and food, you could be looking at almost $30,000 for two kids per year. It is no wonder that more and more families are choosing one parent to stay at home. If you have 3 or more kids, and a job that pays less than $60,000 a year, it is simply not worth it for both parents to work outside the home. It makes more sense for one parent (the one who earns less whether that be the mother or father) to stay at home. But, if you are both working, it is important to look into Dependent Care and Medical Expense Expense or Flexible Savings Accounts (FSA) through your employer. These are great tools to save some money while also cutting your tax burden. Ideally, when you set these up (usually during open season designated by your company’s plan), you designate a yearly amount up front and depending on the number of pay periods per year at your job, the money is taken out pre-tax. That’s right! These are pre-tax dollars which means you do not pay tax on them, and you get all the money back as well (assuming you spend it). So depending on your circumstances, it is a great way to prevent Uncle Sam from getting some of your hard earned money but alas, not all.
Dependent Care FSA
The first of these plans and the one I think parents are the most interested in is the dependent care spending account. The contribution limit of this plan is $5000 per family not per child. Dern! I wish it was per child because $5000 only covers 2-3 months for most families who have two or three kids attending a full-time day care program. It is important to note that this plan is not just for your dependent children but one that you can use for the care of your dependent parents or grandparents as well. This account is also useful for children who cannot care for themselves due to handicap or disabilities beyond the age limits specified for before school/after school care. But, keep in mind that the person or persons on whom the dependent care funds are spent must be able to be claimed as a dependent on the employee’s federal tax return and additionally, the money cannot be used for summer camps (other than “day camps”) or for long term care for parents who live elsewhere (such as in a nursing home).
Unlike medical FSAs (see below), dependent care FSAs are not “pre-funded” and employees cannot receive reimbursement for the full amount of the annual contribution on day one. Employees can only be reimbursed up to the amount they have had deducted during that plan year. So, you may not get your final payment on the full $5000 until after your final paycheck issues in December of the calendar/tax year. Something to keep in mind if your adjusted gross income (AGI) is under $35K, is that you may fare better to taking a deduction on your taxes under something called the Child and Dependent Care Credit rather than do the Dependent Care FSA. If you are dual income or have multiple kids in day care and make over this amount combined you get phased out as your income rises above $35K so by the time you count two incomes, if you make $100K or more AGI it is generally better to utilize the $5000 shelter of a Dependent FSA. Even if you spend $24K in one year on child care expenses, if your AGI is over $100K, you will only see about a $500-$200 tax credit on that entire $24K so better to get your $5K from Uncle Sam through the use of the dependent FSA.
Medical Expense FSA
The most popular however, of these plans, is a medical or health care flexible spending account. You should check the rules on these because they differ but the IRS in 2011 changed the rules for reimbursement for over the counter medicines (OTC) so check the rules before you decide how much contribute. You can read my article at Get Clued In! I wrote an extensive article about flexible savings account and all the changes that took effect January 2011 on reimbursements. Under this plan, you get your prescriptions money back (the co-pays and out of pocket expenses), the deductible you pay on your health insurance can be paid back to you, and the cost of dental, and doctor’s visits and procedures. You can also submit your receipts for some OTC items but check the rules of your plan. The main thing for us parents is that we get our co-pays and deductibles back, and you know as parents of young kids, we are always taking them in to the doctor’s office or ER. Wellness visits are generally covered 100% by insurance but all those extra trips we make for the horrible croup-like cough, the fevers, and all the other fun stuff our kids go through as they build their immunity in school and day care is not always 100% covered so this is a good way to get your pre-tax dollars back tax-free! According to IRS section 125, benefits received from a health insurance plan are not considered taxable income. Also, unlike the Dependent Care FSAs these are pre-funded up front, meaning that if you made an election of $3000 for the whole year of 2011, on January 15 (after your first pay check) you could technically use all $3000 of it even though the money has not been funded yet (if you split it over 26 pay periods). So, if you were to lose your job in March or April, you still get to keep the whole $3000 without paying tax on it. There are provisions in place for the company to pay your remaining share that was not paid into the account yet.
The main disadvantage of these accounts is you lose the money if you do not use it but you get 15 months to use it- January 1 through March 15 (of the following year), so use it! There is currently no federal cap or contribution limits to the Medical FSA but individual companies may impose limits so make sure you estimate your costs properly and read the rules on your plan. It is your money, though, and you should keep as much of it as you can! Warning: The Health Care Reform that passed in 2010 does cap the FSA contribution limit to $2500 but those changes do not come into effect until 2013.
As we mourn the loss of anywhere from 15-35% of our income on this tax day, April 15, 2011, let’s not forget to consider all the tools at our disposal created by Congress and approved by our President to loop around the hefty tax burden we carry. Use those tools if they make sense for you and your situation: Health Care Flexible Spending Accounts, Dependent Care Spending Accounts, the tools previously discussed on Financial Fridays- the State 529 College Savings Accounts, Coverdell ESAs (to save for our kids’ education), Custodial Savings Accounts for our children and and let’s not forget to save for our retirements pre-tax through ROTH IRAs, and our 401Ks through our employers, and Traditional IRAs. These are all great ways to dodge the tax bullet just a little and make sure our families are taken care of as our federal budget dwindles, the deficit increases, and social programs like medicare, medicaid, social security, and such are on the decline. After all, we should all do what we can to become more fiscally responsible and teach our children the same.
*Disclaimer: All parts of this series were written by the author in her personal capacity and not attributed to her profession, or any organizations, employers, or the like that author is affiliated with. The author is interested in these topics and blogs for recreational purposes and not for financial gain. All views and opinions are of the author and not attributable to any company and not meant as an endorsement to any company or organization. Most importantly, author is not a financial expert, tax attorney, estate planner, or accountant, nor works in the financial planning field. This article is written solely for the purpose of sharing information and knowledge with the readers. All readers should consult with their own attorney, tax planner, financial or estate planner, and/or accountant prior to making investment decisions. The author is not liable and will be held harmless for any investment loss or risk undertaken as a result of opening any of the accounts aforementioned.