My company is asking if people would be interested in a “Flexible Spending Plan” that basically allows us to use pre-tax dollars to pay for certain Medical expenses. Here’s how it works.
We enroll, and decide how much pre-tax money to deduct from each paycheck.
The money is regularly deducted from our paychecks and given to a third-party administrator (some other company).
When we spend money, we fill out a claim form and get that money back from our pre-tax savings that is currently in posession of this “third-party administrator”.
Sounds good right? Here’s the part that is the core of my question (and makes me wonder whether this is a scam).
You cannot join mid-year, nor can you change the amount you have taken out (or cancel it) mid-year. Any money you do not spend becomes forfeit and apparently goes right into the pocket of this “third-party administrator”.
This whole thing sounds fishy to me. I guess my question is how can they legally take your money pre-tax, authorize you to spend it on certain medical expenses with no tax, then keep the money if you don’t spend it? Why can’t I instead just use the same medical expenses as a tax-deduction without going to this third-party? What’s the law regarding taxes and medical expenses that allows this?
I have participated in these in the past and my wife is using one now. I believe that other than some administration fees that your company pays them the way they make their money is from the unclaimed fees. I’m pretty sure they operate under a law that was written specifically for the purpose of helping people use pre-tax money for medical and child care expenditures.
Yes, you have to be careful that you don’t put too much into these things. Because I don’t usually have much in the way of medical expenses I only had my part of health insurance premiums taken out. My wife knew ahead of time that she was going to need to have a few crowns in her mouth so we planned for that too. I’d say if you have kids these things can save you some real money. Otherwise I wouldn’t put much into them other than things you know you are going to need like eyeglasses, etc. If you are really meticulous about it you can use it for over the counter meds, birth control, your portion of prescription drugs, etc. But I never felt like dealing with the paperwork was worth it.
On your tax paid money, you have complete control over it.
Pre-tax money has lots of restrictions on it. It is not something that you can treat as a checking account, putting money in when you need to pay bills, and keeping the end of year balance.
Since the money is pre-tax, it will be more money than if is was tax paid. As long as the balance you “lose” at the end of the year is less than the taxes would would have had to pay on the money is you opted out of the program, you come out ahead. Aim low in what you contribute.
Thanks for the responses. Let me rephrase the question though, since that really wasn’t what I was looking for.
Why do I have to go through this third party to spend money pre-tax? Why can’t I just get some forms from the IRS and instead make it a tax deduction at the end of the year? If they can somehow legally make my money pre-tax spendable for certain expenses, why can’t I do it myself without the fear of accidentally contributing too much and losing the money? Is there a law that says “you can spend money pre-tax for medical expenses, but you have to use a third-party to handle it for you”? Why does this third-party keep the money if I don’t use it? Shouldn’t it come back to me and then be taxed as normal income?
Why? Because the government has no interest in making your life easier.
You can deduct medical expenses, thus avoiding the flexible spending plan. But, only if your medical expenses total up to more than 2% of your adjusted gross income. So, if 2% of your AGI is $5000, and you spend $4000 on medical expenses, you lose.
As for why they lock you in so you can’t change the plan, God only knows. Hopefully a tax attourney or legislator will be along to explain the reasoning.
Now, as far as who gets the surplus, I’ve asked at my company’s benefit meetings and the concensus has been that my company gets the money back, not the third party plan administrator. For what that’s worth. My question would then be, why couldn’t the company then give you a ‘bonus’ of whatever amount that was?
Finally, one cool thing about this plan (at least about my plan) - if you contribute $1200 to the plan, $100 a month, you can get all that money out in January if you have $1200 in expenses. You then have the whole year to pay it back, pre-tax, interest free. It’s an interest free loan of your pre-tax money. How cool is that?
If I understand your question correctly, here’s the benefit to you.
If you make (nice round figures here) $20,000 per year and put $500 pre-tax in the flexible spending account, you will only be taxed on $19,500 for that year. So the $500 that you would put in the plan comes right off the top.
By contrast, only a portion of the money you spend on your medical bills is deductible at all, and the amount of the deduction is always less than you would save if you were never taxed in the first place.
On the amount I give in this example, there’s not much benefit one way or the other, because your tax rate would be pretty low to start with. But if you have lots of medical bills, a high gross income, etc., the little savings can add up.
The downside to this, of course, is if you don’t spend it, you lose it. It’s up to you to decide whether the amount you can put away pre-tax offers enough tax savings that you’re willing to risk not spending it all on your bills.
One instance where it always seems to be to your benefit (but I am NOT a tax advisior) is if you deduct your fixed premiums for health/dental insurance, because you know what they’ll be for the entire year. Your HR person or benefits administrator should be willing and able to sit down with you and run the numbers both ways so you can judge for yourself.
We’re getting close here. How come when they (this third-party) does it for me, there is no requirement that it be 2% of my AGI? Basically I can take $1200 out of my salary and buy $1200 worth of medical services/stuff IF I go through this third-party (saving about $400* in taxes). However, if I want to write off about $1200 in medical expenses, requesting a tax refund of about $400*, then I’m not allowed because it’s less than 2% of my AGI. This doesn’t make sense to me. Why can they do it when I can’t?
$1200 after tax is about $1800 pre-tax, tax on the remaining $600 would leave me with about $400 after tax. The amount I would save by using this plan.
FWIW, this sort of plan is also known as a Cafeteria Plan, so if you want more info, search for that name.
My previous employer used one… it’s a nice benefit (from the employee’s perspective) if you can predict some expenses in advance. The plan covers things like the cost of glasses and some dental work, as well as child care expenses (including daycare!), so if you work things out in advance, the tax savings are worth it.
You are correct, douglips, that the employer keeps any unclaimed funds. But, from bitter experience, I can tell you that it is very illegal for the employer to return those funds to the employee as a “bonus” or in any other way. Uncle Sam doesn’t like that.
Also, from an employers perspective, now, I can tell you why we don’t offer one. They are a nightmare to administer because most employees don’t remember them or take the time to learn how to use them. All it takes is one employee to complain about the $65 trapped in the plan to create ripples of dissatisfaction that last forever.
These pre-tax plans are especially good if you have medical procedures done that wouldn’t normally be OKed by your regular health provider: chiropractic, contacts, plastic surgury. IIRC, they will allow you to dip into your flex account to pay these bills.
My company takes all of my allowed expenses out pre-tax: Aetna, dental, long-term disability, basic life, OSSP (?), and vacation buy. (That last one: I can buy up to a week of extra vacation a year by them taking out 1 hour’s worth of pay every week for 40 weeks.)
They also have an imputed group life plan. To make it work, they have to take the premium out of my pay. So every week they add $1.66 to my check, then take it back out for the plan. So I guess I’m really paying $0.46 (28% of $1.66) for it, but what the heck.
Why can’t you? Because the tax code says you can’t. Why is the sky blue? Why are rocks hard?
Deal with it already!
One policy reason for doing it this way is that it insures that people have a source of funds to pay for medical bills if necessary. What happens if you don’t go through the plan and you don’t have the $1200 you need for the kids operation? This way, you are assured that the funds are available.
Another benefit – the government doesn’t get a tax free loan of your money for a year. If you pay with post-tax dollars and deduct, Uncle Sam has the use of your money until you cash your refund check.
With a little forethought, it isn’t hard to calculate roughly how much you’re out of pocket on medical items. Also, the money can be used for a very wide variety of expenses (presciptions, dental work, eyeglasses/contacts, etc…) I find it a useful tool.
douglips is right - any leftover monies not reimbursed to you go to your company to help pay for administrative expenses, not to the third-party administrator.
The reason you don’t get your unused money back - besides “that’s just the way it is” is because the government is not getting the use of your taxes on all the money that you are electing to put into the flexible spending account (FSA). Also, these plans cost the company a lot of money to administer - initial set-up fees, monthly administration fees, salary cost of the HR person(s) who oversee the plan, tax returns, accounting fees, and bank-account fees. The government wants you to be able to use an FSA, but it doesn’t want people to put a whole bunch of money that they never intend to utilize into the plan, only to take it out at the end of the year and thus have cost the government the use of that money for a year and have cost the employer all the money it spent to run the plan.
A company is free to give you whatever kind of bonus it wants, but to offer an FSA and then say you get to get back whatever you don’t use from it is kind of defeating the purpose of the plan, besides being a big no-no as far as the IRS is concerned. What the company would be saying is essentially, “We’re offering this tax-deferred employee benefit plan, but if you DON’T use it, we’ll increase your salary.” Bad bad employer, says the IRS.
Interestingly, there is one type of FSA that does allow you to get back whatever you don’t spend: a Section 132(f) Commuter Spending and Parking Spending Account. This works the same way as an FSA - you elect the money you want deferred each month, you can’t change in the middle of the year, etc. - but you DO get back whatever you don’t use. As far as I know, this is the only type of FSA that doesn’t require you to forfeit any unused monies to the company.
…contribute alot to the plan, put in a big claim, then quit.
I work at an employee benefits consulting company and help create systems that administer Section 125 (cafeteria) plans.
Since health care flexible spending accounts are insurance type plans, you can submit claims for the full amount even if you haven’t contributed the full amount.
So, let’s say you contribute $200 per month for a coverage amount of $2400. You submit a claim for the full amount in January, and get a check for the full amount - $2,400. Meanwhile you’ve only contributed $200. You then quit the company. According to Section 125 of the IRS regs. the company can’t legally collect on the money.
This is another reason FSA’s aren’t popular with some employers.