How Flex Funds Work

With taxes and medical expenses increasing, it isn't hard for U.S. workers to get discouraged. Nothing is more frustrating than working hard all year, just to have the government and the pharmacy eat the fruits of your labor. But there are ways to save on those expenses. One that is becoming increasingly popular is the use of flex funds. You can open a flexible spending account, or FSA, to set aside pre-tax money for health-related expenses not covered by insurance, or for expenses related to dependent care. Some employers even offer FSAs for mass-transit expenses, to help you save money on your commute.

There are many benefits for employees with flexible spending accounts. Their employers are responsible for opening and maintaining the accounts, and they pay all of the fees associated with the accounts. And, using pre-tax income helps lower income taxes. But, there's always the inevitable catch: If you put more money into the account than you can spend on eligible expenses in the year, that money is forfeited. So, careful planning is your greatest investment into an FSA.

Flex spending can be used in more places than people think. Many health expenses qualify as eligible for reimbursement through an FSA. The main idea is to show that the expense is necessary to the employee or his or her dependents, and isn't a cosmetic procedure. You can even use flex funds to pay for your child's braces!

In this article, we'll explore the purposes and uses of flex funds. We'll start by looking at the rules for setting up and using a flex account. If you want to know just how much money you can save with a flexible spending account, read on.

The Purpose of Flex Spending

So how do you know if a flexible spending account can save you money? First, you need to understand how using pre-tax income can help you. The amount you put into your FSA is deducted from your gross income before taxes. So instead of paying income taxes on your full gross income, you pay based on your gross income minus the money you put into the FSA. For example, if you earn $40,000 this year and put $4,000 into your FSA, your gross income is $36,000 instead of $40,000. So using the FSA can help you pay your medical expenses and save on your taxes at the same time.

You can determine how much you want to save with a flex fund each year. There's only one open enrollment period (unless you have a life-changing event, such as divorce, marriage or the birth of a baby), so it's important to think carefully about the amount of money you should contribute. Remember, you forfeit any money you put in but don't use. Currently, the limit is $5,000 per year for Health Care FSAs, and $5,000 for Dependent Care FSAs. So your goal is to determine as closely as possible how much of that money you'll be able to use for eligible expenses. Later on, we'll explore eligible and non-eligible expenses; you may also want to check out an online tax savings calculator.

After determining how much money you want to put in an FSA, you need to contact your employer. Employers should be able to provide information on the different types of flexible spending accounts they offer, the dollar limits and the rules for using the funds, but, here's a list of the most general rules you should understand:

Usually, to use money in your flex fund, you have to turn in a claim form and receipts to show the expense. (Some FSAs have dedicated debit cards, but they're exceptions.) You'll be reimbursed for all eligible expenses, up to the amount you contribute for the year.
You may use the entire year's amount early in the year, but you must continue contributing until you have put in the full amount.
There are different types of flex fund accounts. We'll explore those later, but you must be sure to sign up for the right account, since each has a different list of eligible expenses.
The new closing time for using expenses is 10 weeks after the last day of the year, so you can actually use the year's funds up until March of the next year.
Any funds you do not file a claim for by March are considered forfeited, and are non-refundable. Be sure you check in toward the end of the year to find the balance on your account; you don't want to lose any of the money you contributed.

It's pretty clear that an FSA is a good investment for tax savings. But how do you know if your expenses are covered under the plan? Read on to learn more about the types of expenses that are eligible for reimbursement.

Uses for Flex Spending

It's pretty easy to open an FSA. But it does require some management. You need to pay attention to how much money you have left to spend throughout the year. You also need proof that the money was spent and that it was spent on qualifying expenses. The eligibility of expenses is based on the type of expense and the type of flexible spending account you set up.

There are many ways to use flex spending; most people can probably find several eligible expenses among their routine expenditures.

Health Care FSA: All expenses must be health-related. Cosmetic procedures such as liposuction, tooth whitening and hair transplants are not covered. Some procedures that are covered:

chiropractic services
braces for yourself or your dependents
insurance co-pays and fees not covered under insurance
dental and vision care not covered under insurance
maternity providers, including doulas and midwives not covered by insurance
infertility treatments and providers not covered by insurance
certain over-the-counter medications and products
psychiatric care
prosthetics

Dependent Care FSA: This account is used for reimbursement of expenses related to child or adult care while you're working or looking for work (or while your spouse is a full-time student). These expenses do not include education or tuition fees. Covered expenses include:

day care for qualifying dependents. A qualifying dependent is a child under the age of 13 or an older child or adult who is physically or mentally incapable of self-care. Note, however, that the person providing day care must not be your dependent -- so you can't deduct the cost of paying your older child to babysit your younger child.
day camps and other activities that allow the employee to work
fees for a housekeeper who also provides childcare

Be sure to check with your employer before ruling an expense ineligible. A great tool to determine eligibility is the eligible expenses jukebox [source: FSA Feds]. Finally, IRS Publications 502 and 503 offer extensive lists of what you can and cannot pay for with FSAs [source: IRS]. If you think an expense you have should be covered under your FSA, but it is denied, you can file an appeal. For more information on appeals, contact your employer.

Flexible spending accounts have rules and guidelines, but they can be managed pretty easily. The tax advantages make the accounts well worth the accompanying paperwork. Using pre-tax income to cover medical expenses helps you save more of your paycheck for yourself and your family. And that makes it much easier to keep up the good work.

Lots More Information

Sources:

Coolidge, Carrie. "Flexing Your Flex Account." www.forbes.com/2006/11/17/flexible-spending-health-savings-pf-estates-in_cc_1116money_inl.html. 11/17/06. (4/26/08)
FSAFEDS: Frequently Asked Questions https://www.fsafeds.com/fsafeds/faq.asp#irs1, 4/26/08
IRS. "Flexible Spending Arrangements (FSAs)." http://www.irs.gove/publications/p969/ar02.html#d0e11967. (4/26/08)
Saleem, Haneefa T. "Health Spending Accounts." http://www.bls.gov/opub/cwc/cm20031022ar01p1.htm. 12/19/03. (4/26/08)