Many health insurance plans require insured individuals to incur a certain amount of out-of-pocket expenses when receiving medical treatment. For example, a plan participant might have to make a co-payment for each doctor visit. Individuals who have access to an employee benefit known as a flexible savings arrangement can pay out-of-pocket medical costs with pre-tax dollars.
A flexible spending arrangement (FSA) is also known as a flexible spending account. The cost of funding an FSA is usually paid by the employee through payroll deductions, but the employer may contribute as well. The FSA is then used to pay for qualified medical expenses. If your company provides an FSA option, there are guidelines to follow when funding your account, such as:
Annual contribution limit
Each eligible employee is allowed to contribute up to $2,600 per year to an individual FSA. The tax benefit arises because your contributions to an FSA are not subject to Social Security tax, Medicare tax, or federal income tax. Despite the beneficial tax treatment, many individuals choose not to contribute the maximum amount to an FSA.
Unlike a health savings account (HSA), there are limits on the amount of unused FSA funds that can be rolled over to the following year. As a result, the best option is to contribute to an FSA no more than you expect to incur in out-of-pocket medical costs.
Practical contribution amount
If you are an FSA participant, you must decide at the start of each year how much to have withheld from your pay during the year for the FSA. Because unspent FSA funds are subject to potential forfeiture, you might want to contribute slightly less than what you expect to pay for medical expenses. If your plan allows it, however, there is a rollover exception to consider.
Options for unused FSA funds
If the funds in an FSA are not spent by the end of the plan year, up to $500 of the account balance may be rolled over to the subsequent year. Any unspent amount more than the $500 limitation is forfeited unless your FSA plan provides for a grace period instead.
Rather than adhering to the $500 rollover limitation, your FSA plan may allow unused year-end funds to be spent in the first 2 1/2 months of the subsequent year. An FSA plan can offer the $500 rollover option or the grace period option, but not both.
There is no FSA reporting requirement on your individual income tax return. Contact a financial advisor like those at Harwood Financial Group for more information about tax-advantaged financial accounts.