Good news for people who have out-of-pocket medical expenses, and those who spend big bucks on day care for children or adults: The use-it-or-lose-it rule on flexible spending accounts has been loosened.
FSAs offered by employers allow participants to avoid federal income tax on money set aside for medical expenses and day care.
Previously, money in these accounts could be used only for expenses incurred during the calendar year in which it was saved. But a rule issued last month by the IRS now allows those funds to also be used for expenses incurred through March 15 of the following year.
It’s a valuable change because the most onerous FSA rule stays the same. That says any money not used for an approved expense is lost – turned over to the government. The grace period will give participants a little maneuvering room if actual expenses fall short of the amount saved.
Unfortunately, the grace period is an option that only employers can choose to adopt, though they have no real reason to refuse. If your employer offers FSAs, you might do a bit of lobbying.
FSAs are a great deal. An employee opts to set aside a given sum – typically up to $5,000 a year – and contributions are automatically withheld from his or her paycheck. The sum is subtracted from the employee’s taxable income, reducing federal income tax.
With a $5,000 annual contribution, an employee in the 25 percent tax bracket would save $1,250 in tax.
The employee pays for approved expenses and then files a form to get the sum reimbursed. For details, check with your benefits folks at work.
Tax-free college plans
I’ve long recommended Section 529 plans, which allow tax-free investing for college.
But there’s a problem: The 2001 law that exempts investment gains in 529s from federal tax expires at the end of 2010. Should you use a 529 plan if the child you want to help will need the money after that date?
I think so. If the sunset provision is not amended, the old rules will be restored. Those allow deferral of tax on investment gains until money is withdrawn – similar to what you get with a 401(k) or traditional IRA. That’s a nice benefit, as it leaves money in the account longer to compound.
And any tax on withdrawals would be at the child’s rate, which is usually lower than the parents.’
But the best solution would be to make the tax exemption permanent, and two pending bills would do just that.
The first was introduced two weeks ago by Sen. Chuck Grassley, R-Iowa, chairman of the Senate Finance Committee, and the committee’s top Democrat, Sen Max Baucus of Montana. A similar bill was introduced in the House by Melissa Hart, R-Pa., and Earl Pomeroy, D-N.D.
To comment on these bills, find your members of Congress at one of these Web sites: www.house.gov/writerep/ or www.senate.gov/general/contact-information/senators-cfm.cfm.
Jeff Brown is a business columnist for The Philadelphia Inquirer. E-mail him at brownjphillynews.com.
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