Making the most of your flexible spending account
By Margarette Burnette • Bankrate.com

The final few months of the year mark the open-enrollment season for benefits at many companies. This is the perfect time to consider opening a flexible spending account

flexible spending account (FSA)
A plan to which you contribute money each pay period to cover additional medical insurance coverage or child care. Under this plan, you then receive medical insurance and child care tax-free., or FSA, a workplace benefit that helps you pay certain bills while reaping big tax savings.

Health care and dependent care FSAs allow employees to set aside money to pay for qualified expenses. Each pay period, your company deducts an agreed-upon amount from your check on a pretax basis and deposits it into the flexible spending account.

After incurring a qualified expense, you can be reimbursed with tax-free withdrawals from the FSA.

Flexible spending accounts can be great money-savers, but they come with a catch -- they are use-it-or-lose-it accounts. If you don't claim all of your money for the plan year, you forfeit the remaining funds.

"I think when people hear about FSAs, they're reluctant to sign up when they find out they can lose the money," says Natalie Kaufman, a human resources manager with Altier Credit Union in Tempe, Ariz. "But if you take the time to look at them, each of us can come up with opportunities to save taxes on those accounts."

1. Review the past year's costs
At the beginning of each plan year, you decide how much money to put into your flexible spending account. To avoid leaving money in your flexible spending account at year's end, estimate how much you'll spend next year for qualified out-of-pocket medical or dependent-care expenses.

Typically, health care FSAs can be used to pay for most expenses not covered by your health insurance plan, including co-payments, deductibles and prescriptions. Meanwhile, dependent-care FSAs cover qualified child care and elder care expenses.

A good way to predict future spending is to look at past costs.

"For every medical procedure that you've had done, you should receive an explanation of benefits (from your health insurer) that tells you what the actual cost of your procedure was, what the negotiated rate was and what you paid out of pocket," says Mark Woody, a human resources project specialist at Ent Federal Credit Union in Colorado Springs, Colo. "If you're good at holding on to those forms, you can get a good idea of what you're spending in medical expenses."

Don't forget to include recurring expenses when figuring out your planned FSA contribution for next year. For a health care FSA, these may include purchasing prescription drugs, over-the-counter medicines and contact-lens supplies. For a dependent care FSA, these may include adult day care or child care.

Even if you have misplaced the paperwork or receipts related to these expenses, there are other ways to find this information.

"Many insurance companies today have personalized Web sites where you can look up your past history and explanation of benefits," Woody says.

Credit card statements also can be good sources of information about spending on FSA-eligible expenses.

"There are some credit card companies that will give you an annual breakdown of your spending by category," Kaufman says. "So if you use the same card for your co-pay and deductible, you could get a report of your spending at the end of the year."

And while you're searching for those forms and receipts, make a vow to keep better records next year. Using personal finance software such as Quicken or Microsoft Money is an excellent way to track medical or dependent care spending, says Lyn Dippel, a vice president with the financial planning and investment firm Financial Advantage in Columbia, Md.

2. Set aside money for major work
Flexible spending accounts can be handy for more than small out-of-pocket expenses.

"FSAs are especially useful when you anticipate having a large medical procedure," says Michael Kresh, president of the Financial Planning Association, of Long Island, N.Y.

If you're considering laser eye surgery or purchasing prescription glasses, an flexible spending account could be a tax-free way to pay.

"It's a lot easier to put away $50 or $75 a week into your FSA, instead of paying $1,500 a year at one time (for a major out-of-pocket procedure)," Kresh says.

There are other tax remedies for people with extreme medical circumstances, but the medical bills must generally reach a certain limit.

"Taxpayers don't usually get a medical deduction unless their expenses exceed 7.5 percent of their adjusted gross income," Kresh says. "For example, if you make $50,000 a year, you get no deduction until you pay over $3,700 in out-of-pocket expenses."

By taking advantage of FSAs, you don't have to overcome that high barrier. Check with your tax adviser for more details.

Flexible spending accounts have another advantage over a standard tax deduction -- quicker reimbursement.

"People may not know this, but if you have a large medical expense at the beginning of the year, you can still submit the reimbursement, even though your account balance isn't high enough yet," says Dippel.

This benefit is available to those with health care FSAs. By contrast, you cannot ask for reimbursement from a dependent care FSA until your contribution has actually been placed in the account.

3. Save all receipts
Always keep written proof of your expenses. Many companies now offer debit cards that can be used to pay for flexible spending account expenses, reducing the need to prepare claims paperwork. Although debit cards can be convenient, be sure to keep the receipts just in case your administrator has future questions about a particular expense.

"Have a system in place to store receipts, even if it's just a box on your dresser," Woody says. "My receipts go in my briefcase. At the end of the plan year, which for us is June, I can pull all those receipts together and make a claim. For me, 20 minutes of work per year generates a good deal of savings."

If you've been less organized than Woody, remember that employees now have a "grace period" of two and a half months after the end of the plan year to file claims. So, there is time to track down receipts if they're stuffed in the back of your desk drawer.

4. Know the rules
Sometimes a little detective work can keep you from wasting FSA funds. Many qualified expenses might not seem obvious, so it may be wise to contact your human resources specialist for a comprehensive list.

"Counseling, mental health services and eye care expenses (are qualified)," Dippel says. "Also, people don't tend to think about dental costs, but that's a big category."

Remember that you can apply for reimbursement of these expenses at any time before the deadline, even if the expense was incurred months earlier.

Knowing other rules can also save you money. For example, if you leave a job sometime during the year, don't assume that you need to say goodbye to the money accrued in your flexible spending account.

"If you leave a company, and you have a balance in your FSA account, you can still send in claims as long as they were incurred prior to the date of termination," Kaufman says.

5. Buy medicines with leftover funds
No matter how carefully you plan, it is possible to have funds remaining in your account as the reimbursement deadline draws near. If you get toward the end of your plan period and still have money left in your health care FSA, consider your over-the-counter requirements.

"Get your medicine cabinet in gear for the next year," says Dippel. "Consider getting cold medicines, ibuprofen, Band-Aids -- it's a good time to stock up on those things anyway."

Many drugs that were formerly prescription-only -- like loratadine (sold under the brand name Claritin) -- are now available as OTC medicines. If you do stock up, be sure to check the expiration dates on your products to make sure they are current.

6. Don't be afraid to 'lose' it
The biggest potential drawback of opening a flexible spending account is the risk that you will have to forfeit funds at the end of the plan year. But this fear can be misguided.

"One of the big hesitations people have about FSAs is they're worried about losing the money in their account if they don't spend it in time," says Dippel. "But even if you don't use it -- say you only spend 80 percent of what's in the account -- you're still coming out ahead because of the tax savings."

Consider this illustration: You anticipate paying for a $100 procedure next year. If you make $100 in gross pay, you'll probably receive around $75 in net pay, after taxes. So, to pay for the $100 procedure with taxable funds, you'd have to earn closer to $125 in gross pay to cover your cost.

On the other hand, let's say you put $115 into an FSA account and pay for the procedure with these tax-free funds. Even if you don't spend the remaining $15 before the end of the plan year and "lose" the money, you still come out ahead because you're spending less than the $125 you'd have to earn in taxable funds to pay for the procedure.

The savings are even greater for more expensive procedures.

It's easy to feel like you're rolling the dice when deciding how much money to put into a flexible spending account. Allocate too little and you don't reap as big of a tax savings as you deserve. Allocate too much and you could lose some of the money. Using these tips can help you make smart decisions about flexible spending accounts while potentially saving you a lot of money on your taxes.