How Flexible Spending Accounts Can Reduce Your Tax Burden

Many companies offer a number of fringe benefits in addition to a typical compensation package of a salary and some health insurance. One of the increasingly more common benefits that companies are providing their workers is called a flexible spending account. It essentially allows you to spend money on non-insurable medical expenses without ever having to pay income tax on the money that you spend.

Usually companies have some sort of enrollment period each year in which you can choose to enroll in the company's flexible spending account, or chose to not participate in that benefit. Each company's enrollment period happens during different times in the year, so you'll have to ask your HR department if your company has a flexible spending account (FSA), and if they do, when you can enroll in it.

Flexible spending accounts are a medical benefit that many large and mid-size companies offer for people who would like to set aside money for medical expenses. You can set aside a certain dollar amount out of your paycheck each month, and then pay for medical bills out of that account and never have to pay any payroll, Social Security, or Medicare taxes on that money. This means you'll get about a 25% (or more if you're in a higher tax bracket) bonus on any money that you put into your FSA.

Normally you can have two flexible spending accounts. The first one is a "dependent care" account, which will allow you to pay for expenses for your children or elderly relatives. There's also an "individual" account which pays for your own medical needs. Flexible spending accounts typically cover medical items which are not reimbursed by your insurance. They can be used to pay for hearing aids, contact lenses, prescriptions, some co-payments and over the counter medications. The great thing about your dependent care account is that you can use it to pay for a babysitter or daycare.

You will have to fund each of the accounts separately, so you can't have just have one big pool if money for your expenses and your children's expenses. For an individual account, you can put away up to $3,000 in your FSA.

The one down-side of having a flexible spending account is that if you don't use all of the money by the end of the year, you lose it. If you put away a full $3,000 for yourself one year, and only use $1,000 of it, the $2,000 is just gone back to the government. The tax benefit of the FSA is useless if you lose 2/3rds of your money because you didn't spend it. Make sure that you never put more money away in an FSA than you are sure you'll spend every year. That way you won't lose money by under-spending in your FSA.