what is an fsa

Significant Tax Savings With FSA And Dependent Care Plans

With the use-it-or-lose-it rule and benefit limits, many employees (and some employers) wonder if the tax savings provided by a Flexible Spending Account (FSA) and Dependent Care Plan (DCAP) are worth the risks and hassles.

To show how an FSA and DCAP can provide significant tax savings for your employees, let’s consider the example of Joe Workman, an employee of ABC Company. With doctor’s visits, dental exams, and the annual cost of glasses and an eye exam for his son, Joe usually has about $2,600 in expenses that are eligible under an FSA. Joe and his wife, Beth, both work and have work-related child care expenses of $1,500 per month ($18,000 per year).  Below are two scenarios, showing Joe’s net pay after these expenses both with and without an FSA and DCAP:

Example Tax Scenerio:

Joe Workman  

 With $2,600 FSA/DCAP  

Annual Income $50,000 $50,000
Pre-Tax FSA Election $0 $2,600
Pre-Tax DCAP Election $0 $5,000
Taxable Income $50,000 $42,400

With an FSA/DCAP  
Annual Taxes ~$7,273 ~$5,552
After-Tax Income $42,727 $36,848
Out-of-Pocket Medical, Dental, Vision Rx Expenses $2,600 $0
Work-Related Childcare $18,000 $13,000
Net Pay After Taxes and Expected Expenses $22,127 $23,848

With an FSA and DCAP for his expected expenses, Joe is “giving himself a raise” of over $1,700 a year!

Not only that, but his company saves on Social Security, Medicare, and unemployment taxes with Joe’s elections:

With Joe’s FSA and DCAP alone, his company saves over $500 a year in employment taxes!

Joe Workman

Without an FSA or DCAP  

Annual Income $50,000 $50,000
Taxable Income $50,000 $42,400
Annual FICA and FUTA ~$3,867 ~$3,286

With Joe’s FSA and DCAP alone, his company saves over $500 a year in employment taxes!

Handling the Risk of Use It or Lose It

Despite these potential savings, many employees (and employers) still don’t want to deal with the potential risks associated with FSAs. As you probably know, participants have to use their FSA election within the plan year towards eligible expenses; any unused funds are forfeited to the plan—this is the infamous use-it-or-lose-it.

Employers have options available that can lessen this risk for employees and make the FSA a more attractive option:

Grace Period: The grace period provision allows up to 75 days following the end of the plan year during which participants can use their remaining balance from the ended plan year for new expenses. In an extreme case, this provision would allow a participant who used none of their FSA accounts during the actual plan year to use the entire election on expenses during the grace period.
$500 Rollover: Since 2014, employers have had the option to add the $500 rollover to their FSA, which allows employees to “roll” up to $500 of an unused FSA balance from one plan year to another. This rolled amount simply becomes part of the new year balance and is available at any point during the new plan year.

NOTE – the $500 Rollover option is only available to the Health FSA benefit (not DCAP), and a Health FSA can only have the $500 Rollover OR the grace period option, but not both.

Participant Education:

Most employees are highly unaware of all the potential uses an FSA has. Using resources such as a list of common eligible expenses or sites like FSAStore.com can help educate your participants and ensure they use the maximum amount of their FSA possible.

The benefit experts at B3PA can provide you with even more information on how a Health FSA and/or DCAP can be a great addition to your benefit package. For answers to your questions or to begin setting up this benefit contact B3PA or their sister company HR Service at (833) 685-8400 x 1

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