The rising costs of healthcare mean it's essential to set aside money to cover your medical expenses. If you're fortunate enough to have a flexible spending account at work, you can use it to set money aside for healthcare costs and reap some valuable tax benefits, too.
The rules governing FSAs change nearly every year, so it's important to stay up to date with the latest on how you can put these tax-favored accounts to work. Below, we'll look at the changes affecting FSAs in 2020 to help you decide if a flexible spending account makes sense for you.
These changes will affect FSAs in 2020
Those who are familiar with flexible spending accounts know that the amount you're allowed to save in an FSA for your medical costs typically goes up with inflation every year. That was again the case in 2020, with the maximum contribution amount climbing by $50 from 2019's number to $2,750.
As is usually the case, those who use FSAs to save toward the costs of dependent care will see the same limit as last year. For those who file as single, head of household, qualifying widower, or married with a joint return, a $5,000 annual limit applies to FSA contributions toward dependent care costs. Those who are married and file separately have a lower contribution limit of $2,500.
If you're married, some additional restrictions on FSAs for dependent care can apply. First, the $5,000 maximum applies to the couple in total, so if both spouses have access to their own FSAs, they can't both make $5,000 contributions. Moreover, both spouses have to have earned income in order to contribute to an FSA for dependent care, and if one spouse's earned income is less than $5,000, then that smaller amount becomes the contribution limit.
Why FSAs are worth a look
FSAs can have huge tax benefits. The biggest benefit from flexible spending accounts is that you're allowed to divert money from your paycheck without having income taxes or payroll withholding taxes taken out of it. That leaves you with more money to spend on your healthcare or dependent care expenses.
For instance, say you set aside $2,750 in a healthcare FSA. If you're in the 22% tax bracket, you should see your income tax withholding go down by just over $600. In addition, withholding for Social Security and Medicare payroll taxes will be about $210 less than it would've been. In essence, in exchange for saving $2,750, you'll get a subsidy of more than $800 from the federal government through tax savings.
The main problem with FSAs
As valuable as they can be, FSAs also have a drawback. You can end up forfeiting your contributions if you don't use them by the end of the year.
However, employers have a couple of choices to ease the blow somewhat. Many employers give their employees a grace period of two and a half months to use prior-year flex money. Others don't provide a grace period but instead let employees carry forward up to $500 of unspent money to use in the new year. However, keep in mind that some employers don't offer either of these provisions, so you'll want to check with your payroll department to find out which rules apply to you.
The tax benefits of flexible spending accounts make them worth the potential risk of forfeiting unspent money, especially for those who have predictable healthcare and dependent care expenses. Those who have access to FSAs at work should look closely at how they can best use them to plan for their costs and reap the rewards.