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  • Financial Planning: Article

    By Sharon Bonnem, CFP®, Faculty Coordinator and Cindy R. Riecke, MSF, CFP®, ChFC, CLU, Senior Director, Content Development, Kaplan University School of Professional and Continuing Education
    Published November 2014

    October is commonly the “open enrollment” period for employee group benefits. Many individuals find the task of comparing choices daunting, and as a result, default to the same options they current have (after getting a third reminder from HR that the deadline is approaching!). A little guidance and education could help your clients save quite a bit in taxes.

    Let’s start with the basics. An employee can elect to place up to $2,500 of their pay in a flexible spending account (FSA) and use this to cover a variety of otherwise out-of-pocket medical expenses–deductibles, co-pays, orthodontic work for the kids (or the adults!), eyeglasses, and much more. The funds go into the account without any deduction for federal, states, or FICA tax.  Assuming your client is in the 25% federal and 5% state tax brackets for purposes of illustration means that 37.65% of every dollar they earn is given up in taxes (30% in income taxes plus 7.65% for FICA). While most individuals agree they would like to pay fewer taxes, talking in terms of dollars can make for a more compelling argument:

    Let’s say junior needs braces. Good news—you discover your dental insurance will cover all but $2,000. If you do nothing—do not set up a flexible spending account—you’ll need to earn $3,207.70 to cover the cost: $3,207.70 earned: $1,207.70 in taxes and FICA will result in $2,000 in your pay, which you will use to pay the bill.  Or, you can earn just $2,000 to cover the cost by utilizing your FSA.  

    Another benefit of paying this bill via the FSA account is that your contributions to the account are spread out over the entire year, even though the orthodontia bill may come due (and be paid) in February. If you are paid bi-weekly, you will have $76.92 taken from your earnings each week ($2,000/26 pays). Also remember if you weren’t putting this $76.92 in your FSA, you would only see about $48 of it in your paycheck, because taxes will apply.

    Have you convinced them to participate? Not yet. The one thing most employees do know about FSAs can be summed up in five words: “use it or lose it.” In other words, the money that the employee elects to put into the FSA will be forfeited if not used. While this is certainly a consideration, and the client will want to estimate FSA eligible expenses conservatively, this should not be enough to deter someone from the possibility of potentially saving $1,000 or more in taxes. In the preceding example, assume the client overestimated their expenses for the year; instead of $2,000, actual expenses are $1,800. The client forfeits $200 (which, incidentally, would have been about $125 in their pay). Nevertheless, by paying $1,800 through the FSA, they’ve saved considerable more in taxes than the sum forfeited.

    In addition, many plans allow a “run out” period of 2.5 months, and any money left from the previous year can be used to pay eligible expenses occurring during this grace period.

    The most recently development, further increasing the flexibility of FSAs, is spelled out in IRS Publication 969:

    For plan years beginning after December 31, 2012, plans may allow up to $500 of unused amounts remaining at the end of the plan year to be paid or reimbursed for qualified medical expenses you incur in the following plan year. The plan may specify a lower dollar amount as the maximum carryover amount. If the plan permits a carry-over, any unused amounts in excess of the carryover amount are forfeited. The carryover does not affect the maximum amount of salary reduction contributions that you are permitted to make.

     

     

    Sharon Bonnem is a faculty coordinator at Kaplan University School of Professional and Continuing Education and Cindy R. Riecke is senior director, content development at Kaplan University School of Professional and Continuing Education. The views expressed in this article are solely those of the author and do not represent the view of Kaplan University.

    The contents of this article are presented for informational purposes only and are not to be relied upon for financial planning, insurance, or tax-related services. Always check with a professional regarding any questions you may have regarding these services.

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