If your employer offers a flexible spending account, and you aren’t using it, you’re literally giving money to the Internal Revenue Service unnecessarily.
Many employers offer flexible spending accounts in their benefits package. These accounts are structured by federal law to allow payment of most medical-related bills using “before tax” money.
Unfortunately, the law creating flexible spending accounts also requires money that is left in the account at the end of the benefit year to be forfeited by the employee. This feature scares off many would-be flexible spending account participants. They’re afraid of losing money.
There’s really no excuse for the law to require the forfeiture of excess money. Any reasonable person would allow the excess to roll over into the next benefit year.
Nevertheless, even if you don’t spend all the money in your flexible spending account you can still save money overall depending on your income tax rate.
For example, if your income tax rate is 30% and you contribute $1,000 to a flexible spending account; the $1,000 contribution in subtracted from your gross wages before tax is applied. Since your taxable income is $1,000 less, your income tax will be $300 less (30% of $1,000).
So, by contributing $1,000 to your flexible spending account you save $300 on your income tax return. If you end the benefit year having used only $800 leaving $200 forfeited in the account – you’ve still saved $100 net. The tax reduction gives you a fair amount of flexibility that increases as your tax rate increases.
If you contribute $1,000 and:
1. Your income tax rate is 35% then you have a net savings from your flexible spending account as long as the forfeited amount is less than $350.
2. Your income tax rate is 25% then you have a net savings from your flexible spending account as long as the forfeited amount is less than $250.
3. Your income tax rate is 15% then you have a net savings from your flexible spending account as long as the forfeited amount is less than $150.
4. Your income tax rate is 0% then you have no net savings under any circumstances.
Still, if you contribute $2,000 to a flexible spending account but have only $800 in qualified medical expenses then you have a net loss of $600 ($1,200 forfeited less $600 tax savings assuming a 30% tax rate); a very undesirable outcome.
Flexible spending accounts are an easy way to save money on your income taxes – even if you forfeit a smaller amount at the end of the benefit year.
The topic of the next post will be calculating a “safe” annual contribution to your flexible spending account.
Link to Other Topics in the Special Report: Cutting Expenses