A Flexible Spending Arrangement (FSA) allows an employee to designate up to $2,500 of wages to pay for certain health care costs and up to $5,000 for dependent care. These are separate parts of an FSA and must be enrolled in separately.
Contributions to FSAs are not only free from income tax but also from payroll taxes. For workers with wages under the Social Security wage base (which is $127,200 for 2017) this is a tax savings of 7.65% in addition to income tax. For someone in the 25% tax bracket, this comes to a savings of almost 33% (for most New York State tax payers, add another 5-6% in savings).
The only drawback of the FSA is the “use it or lose it” rule which requires you to use the FSA contribution by the end of the year or lose it. This means you have to be pretty sure of what your out of pocket costs will be, which might be hard to do for medical and dental expenses. Most plans now allow a grace period of 2 ½ months after the end of the plan year (March 15th for most plans).
You can also carryover up to $500 to the next year. So, for example, if you designated $2,500 last year for FSA but only spent $2,000, you would have $3,000 available during the new year – not just during the 2 ½ month grace period).
While the $500 carryover is now permitted, it is up to each employer to modify its plan to allow for it. Employers may still offer the 2 ½ month grace period but not both the grace period and the carryover. Be sure to check on your employer’s plan.
For people using child care, this is much better than taking the child care credit. It is also easier to predict your costs (summer camps can also qualify, as long as they are not sleep away camps). You must report child care costs on your tax return so be sure to obtain the provider’s tax ID number.
Enrollment in this plan occurs a couple of months before the new year starts. But if you have a “significant life event”, such as marriage, divorce or birth of a child, you can enroll during the year. Check with your benefits rep so you don’t miss the enrollment deadline.