Flexible spending accounts (FSA), or, cafeteria plans, offer employees a menu of services they pay on a pre-tax basis. Authorized under Section 125 of the Internal Revenue Code, cafeteria plans allow employees to set aside money throughout the year to use toward medical or dependent care expenses not covered by health insurance benefits, including co-payments and deductibles.
By setting aside money during the year for medical or dependent care services before taxes, employees are able to reduce their taxable income, which increases their take-home pay. Taxes are not paid on claims paid to employee from the account either.
When you sign up for a flexible spending account, it is important to know that the money deducted from your pay throughout the year must be used or they will lose it. Therefore, deducting too little is better than too much. A cafeteria plan is not a savings account – the funds do not build up year after year.
The federal government allows two types of spending accounts. One is for medical reimbursement and the other is for dependent care spending, whether it’s for child care or care for an elderly family member.
The IRS does not set limits on the amount of medical and dental expenses that can be reimbursed by a spending account, buy your plan may establish annual maximums. Be sure to check to find out what yours are.
When filing income taxes, you must complete the IRS Form 2441 if you participate in a dependent-care spending account. Dependent-care contributions are reported in Box 10 of the W-2 forms.
Sometimes your flexible spending account administrator will provide a worksheet to help you determine how much money you should set aside for medical and dependent care expenses. Here are some questions to ask yourself to help determine an amount:
- How much did I spend in child care or care for an elderly parent last year? Are those costs expected to increase or decrease this year?
- How much did I pay in co-payments this year for prescriptions and doctor’s visits?
- Will I or someone in the family need eyeglasses or contacts this year?
- Is it likely someone will need surgery?
- What did my family spend last year in trips to emergency room?
- Are there other expenses, like therapy, chiropractic treatment or orthodontia that someone in my family may need?
- Do I have vision and dental benefits? What do they cover?
Be sure to review your health care plan before you finalize an amount to be paid into your flexible spending accounts, even if you opt to stay with the same plan you had the year before. Co-payments may have increased or benefits reduced.
You can change the amount of allocations to your cafeteria plan if you have what the IRS calls a “qualifying event.” A qualifying event would include the birth or adoption of a child, death of a spouse or dependent, marriage, divorce or change your job status or that of your spouse. Most changes have to be made in writing within 31 days of the event.
Plan wisely when determining your cafeteria plan. Ask your benefits administrator if you have any questions.