Episode Transcript
Brenton: [00:00:00] In last week's episode, we talked about health savings accounts and their many benefits, including the ability to put aside funds that you can use in your retirement years.
In this episode, we share details about the first cousins of HSAs, dependent care flex spending accounts and flex spending accounts.
Let's get started.
Brenton: Hello, my name is Brenton Harrison of New Money, New Problems and your host for the New Money, New Problems podcast. I hope you enjoyed our episode on last week where we talked about the benefits of health savings accounts. And the reason we're doing it at this time of year is because October and November are typically Open Enrollment Period for many employees where they pick the employee benefits that you're going to use over the upcoming 12 month period.
Not to recap the [00:01:00] entire episode, but just a helpful quick summary of an HSA is this an account where you can put aside money that has three tax benefits. You put the dollars aside pre tax, which means you save on your taxable income in the current year.
As the money grows and it's invested, it's tax deferred, meaning you don't owe taxes on the growth. And when you take it out for dedicated health expenses those funds are not taxed either. These plans have to be paired with a high deductible health plan. We mentioned that high deductible health plans typically cost the least amount of money on a monthly basis, but that's because you're on the hook for a higher amount if you have to go to the doctor, if you have to go to a specialist. So it's something that you want to do with caution and making sure that you don't have health concerns. That would mean even though there are a number of benefits to an HSA, you still would be better off using a more conventional, lower deductible plan where the insurance company comes in to help you with costs a little sooner.
So for all the benefits of the HSA, there are also some modifications like the high deductible health plan that you have to keep in [00:02:00] mind when it comes to structuring whether or not it's the right thing for you.
This week, we're going to talk about the first cousins, as I call them, of the health savings account. Those accounts are the dependent care flex spending account and flex spending accounts. And these accounts have a number of similar features. And I want to walk you through both how they're similar to HSAs, how they differ.
And after the break, we'll get into some specific case uses of when you might consider using them for your employee benefits.
Let's start with the flex spending account. Very similar to the health savings account, a flex spending account is something that you typically are going to use for things like dental care or diagnostic work for your health or prescriptions, things of that nature, over the counter medications. All of these things can be paid for with funds that are put into a flex spending account.
You put these dollars aside and just like in the health savings account, you do so pre tax.
So just like last week in our example, we had a person who had a 3, 000 bi weekly paycheck and they were putting 200 [00:03:00] aside or maybe it was 300 into their health savings account that lowered the income on which they pay taxes by that same amount. So you're paying taxes on a lower amount That means you're paying less in taxes.
That means your take home pay is higher. It is the same for flex spending accounts. Now unlike a health savings account, a flex spending account does not have to be paired with a high deductible health plan in order to open the account.
Regardless of the health insurance plan you have, if you have an FSA available you can sign up for this plan and you can put aside 20, 50, a hundred dollars a pay period, as long as it falls under the 2023 contribution limits.
And in 2023, those contribution limits are 3, 050 per year per employee.
And if you're within that 3, 050, you can use all of those funds for the expenses that I referenced. We're going to put a link in the show notes that show you all of the eligible expenses for an FSA because there are a ton of them.
And also like the [00:04:00] HSA, Many of the larger retailers like your targets, your Walmart, your Amazons, they have dedicated pages on their website where you can go to those pages and everything that's there is already approved as an FSA or HSA eligible expense. So you don't even have to worry about it.
You just go on the site. Whatever you buy is something that can be reimbursed if that's the way your employer works, where you pay for it yourself and then get reimbursed out of your FSA, or many larger employers are starting to do FSA credit card style cards, where you actually get a card similar to a debit card or a credit card.
And whatever's loaded on that card is your FSA account balance, and you can use that account balance to pay for those expenses, either at the doctor directly or online at a retailer like that target or that Amazon.
Now with an HSA, those funds roll over and the unused funds can be invested as the years go on. So you don't have to be that concerned with an HSA that you might have put more into the account than you plan to use [00:05:00] from that year to year basis. With an FSA, it kind of straddles the line between what we're going to talk about with the dependent care FSA and an HSA.
An HSA, you can roll over those funds from year to year. A dependent care FSA, you cannot roll over any funds if you don't use them by the end of the year and whatever grace period your employer might offer, those funds go away completely. With an FSA it works a little differently.
With an FSA, it is almost a use it or lose it account, where just like the dependent care FSA, if you don't spend it by the end of the year or the end of the grace period, those funds will go away. But there is a small exception called a carryover. If your FSA plan allows it with your employer, and this is something you have to ask. If they allow it, you can roll over in the year 2023 up to 610 from one year to the next. So, for example, let's say that at the end of the year, or at the end of your plan's grace period, you have 1, 000 in your FSA that's unused.
You would need to make sure you spend at least [00:06:00] 390 of those funds because only 610 can be rolled over. And in this scenario, that 390, if not spent, would be completely lost. You forfeit it back to the plan.
Now let's cover the other first cousin, Dependent Care Flexpending Accounts. And I cannot express this strongly enough. This is an amount of money that I see young parents forfeiting every single year because of pure lack of awareness of the many eligible expenses that you can pay for using a Dependent Care Flex Spending account. Think of a dependent care flex spending account as something not for your health, but for the care of either your children or your elderly loved ones.
If you have a dependent on your tax return, like a parent for which you're caring or a child that's in your household, the things that are associated with their care and wellbeing can often be covered by a dependent care flex spending account. We'll put a link to this in the show notes as well, but I just want to go over some of the many things.
I think this is worth taking a minute or so to go through some of the expenses that can be paid [00:07:00] for. Dependent or elder care while you work. So if you have childcare while you're working, or if you have elder care while you're working, it can be paid for with a dependent care FSA, elder care, housekeeper who cares for your child,
a nanny, nursery school.
Day Camp, like a summer camp for your child, custodial elder care, child care, a before or after care program,
babysitting by a relative who is not on your tax return as a dependent, an au pair, an after school program, an adult day care center.
Preschool tuition. Yes, you can pay for tuition out of your Dependent Care Flex Spending account as long as your kid is not in kindergarten or older. You can pay for tuition using these funds. Registration fees related to school. Payroll taxes related to the eligible care if you're employing that person.
Sick child care.
Even transportation to and from eligible care if it's provided by an eligible caregiver. All of these things can be paid for with funds that you put [00:08:00] into a Dependent Care Flex Spending account. Pre tax. And for those who are in a household where you're not married, filing separately or not single, you can put up to 5, 000 in the tax year 2023, 2, 500.
If you're married filing separately or you're single, but these are things that if you have children, you definitively use. Even if your child goes to public school, they probably go to a day camp or a summer camp. You have registration fees when it's related to school processing fees for those registration fees.
These are just easy expenses that you know you're going to have to spend for your child. And if you put them in a dependent care flex spending account, you're paying for something you had to pay for anyways, but you're not paying income tax on those funds because just like the FSA, just like the HSA, funds contributed to a dependent flex spending account come out of your paycheck pre tax.
So I want you to think about this. If you have a child who's in daycare, and you're like one of the many people out there in this country who are paying 1, 000 or 2, 000 or more a month to make sure that your child has a place that you consider safe. [00:09:00] If you have them in a private school, if you have them in a day camp, if you have them in an aftercare program, even at a public school or at the YMCA that has an extra expense, these are things where you can get an estimate for how much you're going to spend on them each year. You can put them into your dependent care flex spending account. So that amount is put into the account and contributed over the 12 month basis. And just like a flex spending account, many employers will give you a card where you can spend off of that card, or they will do reimbursement where you pay for it yourself, submit it for reimbursement, and the funds are dispersed from your dependent care flex spending account.
And I don't want you to underestimate what this could mean to your tax burden. Let's say that we had a family who decided to max out their flex spending account at 3, 050. And then they also decided to put the full 5, 000 into a dependent care flex spending account.
That's 8, 050 in total that they had come out of their check pre tax, which lowers their taxable income by that same amount.
Let's also go back to our tax lessons [00:10:00] and recall the term marginal tax rate. The marginal tax rate is the percentage of tax that you pay on the highest portion of your income. It's where that highest portion falls on that progressive scale that we use for our taxes in this country. So let's assume that our couple in this scenario is in the 32 percent marginal tax bracket.
This would mean that if I put aside 8, 050 pre tax, and it was all in that 32 percent tax bracket, they are saving over 2, 500 in taxes that year, just by paying for things that they already had to pay for anyways.
So, I can tell you, to be transparent, it's an extra step.
It's a little more difficult than just paying for it off your credit card. You do have to make sure that you have it taken out of your paycheck and potentially get reimbursed or load up your card. But if I told you that by doing that, you would save in this example, over 200 a month in taxes, it might be worth taking that extra step for your family because unlike the HSA, you can do both of these tools without [00:11:00] having to change the underlying health coverage that you have in place for your family.
After the break, I'll tell you how you can estimate what you might be paying for on a yearly basis and how to make sure you don't have unused funds in either of these accounts at the end of the year
[00:12:00]
Brenton: All right, so how do you make sure you don't get left holding the bag when it comes to your Flex Spending account and your dependent care Flex Spending account? With your Flex Spending account, I'm less concerned that you would be left with money that you can't use more so because of the many ways that you can use these accounts.
For example, if you're following along with us on screen, I'm on the Target FSA website. It allows you to purchase everything from skincare to eye care, like eye drops and contacts and glasses, first Aid, like band aids and bandages, medicines like over the counter medications, or even if you have prescription, even in my house, if you have a little kid who's running around with a snotty [00:13:00] nose all day, some Advil cold and sinus would be something that you keep on stock.
Incontinence, sexual health, like birth control and condoms, baby. Baby Items, Home Health Cares like Thermometers, Vitamins and Supplements, Oral Care, Foot Care, Feminine Care, pretty much everything that you can think of that you would go to a Walgreens or a CVS or a Duane Reade to purchase, you can buy with an FSA in addition to the things like Copays.
So you do want to make sure that you at least have some idea of about how much you spend on your health each year and stay within some realm of that. But to me, 3, 000 is not that much to spend for a family on their health when it comes to copays and things of that nature. If you find out that you're only spending a thousand dollars a year, maybe you don't go to 3000. Maybe you do 1500 or 1600 so you can stay in that window where you can roll over those 610 of unused funds. But it's not out of the realm of imagination that even if you got to the end of the year or the end of your plan's grace period, [00:14:00] it had a few hundred dollars left that you couldn't go to one of these websites and just stack up on as much as you need to make sure that you don't lose the money.
But maybe you have enough band aids to last you until your child is 18. That's something that you can more easily do with the FSA when you combine the eligible uses with the fact that you can roll over 610 of unused funds.
Now, I'm a little more concerned when it comes to families with dependent care FSAs, because that is truly a use it or lose it account.
If you get to the end of the year and you have a 1, 000 left and you can't figure out something to pay for it with, then that thousand dollars is forfeited. So you may not have paid taxes on it, but you didn't get to use it either. So in these scenarios, I would invite you to do a sweep of what you've done in prior years for your children, or what you know is upcoming that you haven't paid for before.
As an example, many people do pay for registration fees for their kids without thinking about it. They pay for summer camp just to make sure their kids out of the house and not knocking things down in the middle of the day while you're trying to work, but they don't really think about how much they [00:15:00] pay per week.
They don't think about how much it might be for aftercare or how much you might pay for babysitting during the year. And as a caveat, I will say when it comes to babysitting, you can't just pay the kid down the street 20 an hour and then expect to claim that 20.
If you're going to pay for babysitting or childcare, you have to make sure that you give that provider a 1099 or a W 2 tax form at the end of the year. They have to register that income in order for you to be able to claim it. But for all of these things, we often spend them on our children, but we don't think about how much they total up to on a year to year basis.
So I would encourage you to go back over the previous year and see how much you spent and kind of line what you're taking out of your paycheck to go into that account up with that number. Add to it things that you know are upcoming in the next year. Maybe your kid's going from elementary school to middle school and there are some extra expenses associated with that.
Maybe they have to buy more supplies or be part of an afterschool program that they haven't been in before. So if you can estimate those expenses as well, [00:16:00] add them on to the total. You can make sure that those use it or lose it funds are not actually lost at the end of the season.
This is really important because with both of these plans, FSAs, dependent care FSAs, most employers do not allow you to adjust the amount that's coming out of your paycheck every two weeks in the middle of the period. You can't just go in the middle of the year and say, I want to reduce how much I'm contributing.
You'll have to just face the prospect of losing those funds and then change your withdrawal amount in the upcoming open enrollment period. So you want to make sure you've at least done some due diligence, but I assure you that there are some real tax benefits out there for families for which this is a fit that often go unused again because of a lack of awareness of the many ways that it can help you both from a tax standpoint and most importantly from a month to month budgetary standpoint as well.
That's the end of the episode this week. We'll be back next week with some more employee benefits that often go underutilized. So you can make sure you have an idea of what you do have and don't have [00:17:00] accessible to you at work. And I look forward to seeing you in that episode.
