As we move into the fall, and particularly as companies begin to rethink their operations and benefit packages in light of COVID-19 and what may become a new normal, it’s a good time to revisit your healthcare and dependent day care flexible spending account programs.
Flexible Spending Accounts Explained
A flexible spending account (FSA), is a tax-favored savings vehicle that allows employees to put aside a portion of their pay pre-tax to pay for certain eligible expenses. FSAs are set up by an employer for its employees.
Two Types of Flexible Spending Accounts
A healthcare flexible spending account allows employees to contribute to their accounts to pay for qualified medical, dental and vision care expenses.
A dependent day care flexible spending account allows employees to contribute to their accounts to pay for qualified childcare expenses for children up to age 13. It can also be used to pay for the care of qualifying adults, who cannot care for themselves and meet specific Internal Revenue Service (IRS) guidelines.
How Flexible Spending Accounts Work
- Employees’ elected contributions are deducted from their pay, pre-tax, and contributed to their account - lowering taxable income.
- The IRS limits how much an employee can contribute to an FSA account per year.
- For healthcare FSAs, the 2020 limit per employee is $2,750.
- For dependent day care FSA accounts, the 2020 limit per employee is $5,000. Employees who are married but file joint tax returns with their spouse have a lower limit.
- Employers may choose to contribute to an FSA, but they do not have to—if they do, their contribution does not reduce the amount that an employee is permitted to contribute.
- Funds that are not used during the plan year are forfeited
- Employers may design their FSAs to allow employees flexibility in using up funds. Employers may apply a grace period, which is a period of time after the end of the plan year during which employees may still incur claims. Alternatively, an employer may allow employees to carryover up to $550 of unused funds to the next plan year.
6 Benefits of a Flexible Spending Accounts
- Tax Savings: Employees contribute to their FSAs through payroll deductions, so the money is taken out before taxes. This reduces taxable income, which means participants will owe less federal taxes.
- Medical Savings: Health insurance doesn’t always cover expenses such as over-the-counter drugs, travel vaccines and diagnostic tests. Healthcare FSA participants can pay for these items with their FSA funds.
- Family Healthcare Coverage: Expenses incurred by family members may be reimbursed from the account.
- Increased Take-Home Pay: An FSA reduces the employee’s federal and FICA tax burden; thus, it can ultimately increase his/her take-home pay.
- Immediate Availability of Funds: With respect to a healthcare FSA, employees’ total annual election (less any paid reimbursements) is available regardless of actual year to date payroll contributions.
- Debit Card: Many FSAs are connected to debit cards so participants can use the card to pay for qualified expenses at the point of sale rather than submitting claims.