A flexible spending account, or FSA, is a good way to save up cash for medical and childcare expenses. The money in the account is tax-free as long as it is used for an approved purpose. You can use an FSA to pay for deductibles, prescriptions and other medical expenses. You can also set up a separate account to pay childcare expenses. Just don't forget you've set the account up: the one drawback to an FSA is that if you don't use the money within the allotted time period, you forfeit it.
How Does it Work?
If you have a flexible spending account plan at work, there will be an enrollment period during which you can elect to divert a portion of your pay into the FSA. You do not pay tax on the money as long as you use it for an approved expense. As of April 2012, you can put up to $2,500 annually if you are single or $5,000 if you are married into both a medical and dependent care FSA, for a total of $5,000 if you are single or $10,000 if you are married. Once you have designated an amount, you cannot change it until the next benefits year.
Use it or Lose it
An FSA is a "use it or lose it" account. The Internal Revenue Service requires you to spend all the money in the year in which you contribute it to the account. However, the IRS does allow companies to have a grace period of up to two and a half months, giving you until March 15 of the following year to spend the money. Your employer keeps any unspent money in the account at the end of the year or the end of the grace period.
Because you can only spend the money for approved purposes, you should plan carefully to make sure you don't put more in an FSA than you can use. Dependent care FSAs are easier to plan for, because you usually know how much you are going to spend in a year on child care. For medical FSAs, it makes sense to be conservative. Unless you know you have a major medical procedure scheduled, or you are going to have a baby during the year, you might want to save less than the maximum to ensure you don't lose any money.
To make sure you don't forfeit any of your FSA money, you need to be smart about how you spend it. For example, if it's December 15 and you have $500 left in your FSA, start looking for ways you can use the money. Perhaps you could use a new pair of glasses. Or maybe you can get your doctor to prescribe six months' worth of your cholesterol medication at a time. Keep in mind, too, that you can spend your FSA money before it's been taken out of your check. If you incur huge medical bills in January, you can spend all $2,500 in your FSA, even though very little has been deducted from your check at that point.
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