Starting next July, federal employees will be able to take advantage of flexible spending accounts, the newest feature of the government's benefits package.
The flexible spending accounts will lower employees' tax bills by letting them stow away money from their paychecks before taxes are taken out. Employees will be able to put aside up to $3,000 for medical expenses and up to $5,000 for child and dependent care. Someone who makes $60,000 a year and puts away $1,000 for medical expenses and $3,750 for child care expenses could cut their federal tax bill by $1,645. (Try this calculator to get an estimate.)
With the money in their accounts, employees will be able to pay for many medical expenses not covered by standard health insurance. They will be able to use the money to cover their regular insurance plan's deductibles and co-payments, to purchase eyeglasses or contact lenses, to get dental work done and to have laser eye surgery. (A complete list of services that can be covered by flexible spending accounts appears at the end of this column.) They will also be able to use the money to pay for the same services for their dependents. Dependent care accounts-which are limited to $5,000 per family, not per spouse-will cover day care for children under 13 or incapacitated spouses and parents.
Employees won't be able to pay for long-term care insurance premiums or life insurance premiums with flexible spending account money.
Flexible spending accounts reimburse employees for expenses. The accounts don't pay for services up-front. Employees submit receipts to their employers, which then reimburse them from the flexible spending accounts.
By offering flexible spending accounts to employees, the federal government is catching up with the private sector, where 69 percent of companies offer the accounts to their workers, according to the Society for Human Resource Management. Flexible spending accounts will not be available to retirees. That would require a change in law.
The government's flexible spending accounts will be governed by the same laws and regulations, mostly in the tax code, that govern private firms' accounts. The $5,000 limit on child and dependent care, for example, is set in law. The Office of Personnel Management has yet to work out the details of the flexible spending accounts, but the basic rules for the accounts are well-established.
A key rule that may deter people from setting up the accounts is the so-called "use-it-or-lose-it" provision. To prevent wealthy people from using the accounts as tax shelters, the law requires employees to forfeit any funds they don't use in a calendar year. So if an employee sets aside $1,200 in a flexible spending account and only uses $600, the employer keeps $600. It cannot refund the $600 to the employee.
Ken McDonnell, a research analyst with the Washington-based Employee Benefit Research Institute, said people can avoid forfeiting funds by putting less money into their flexible spending accounts than they expect to spend. For example, if he expects to buy glasses that cost $350, he'll put $330 in his flexible spending account. "It comes down to: would you rather give that $20 to your eye doctor or to your employer?" McDonnell said.
Employers can do whatever they want with the forfeited funds. Many hold onto the money to defray their program's costs. The administrative costs of a program are often more than covered by the reduction in the employer portion of the tax bill, but another feature of flexible spending accounts can put employers at financial risk.
Say an employee decides to contribute $1,200 in a calendar year to a medical flexible spending account. Fifty dollars is deducted from each of the employee's first two paychecks. The employee gets laser eye surgery for $1,200 at the end of January. Even though the employee has only contributed $100 to his spending account, the employer has to reimburse the employee for the whole $1,200. For the employee, it's the equivalent of an interest-free loan.
But if the employee quits at the end of February, after the employee has contributed another $100 to the account, the employer is out $1,000. Employers may hold on to other participants' forfeited funds to cover that cost.
While employers have to make the whole annual amount of medical accounts available to employees at any time, employers don't have to do the same for dependent care accounts. "A participant is only entitled to reimbursement of amounts actually contributed to the plan and available in the participant's account at any given time," the IRS says of dependent care accounts.
Because child care costs are easier to predict than medical costs, people should have less fear about the use-it-or-lose-it rule when setting up dependent care accounts than when setting up medical accounts. As long as people are conservative, they should be able to avoid forfeiting any funds.
The Employee Benefit Research Institute's McDonnell said the use-it-or-lose-it rule often sends people into a spending rush in November and December. While employees have to obtain the services in a given calendar year, they typically have until the following April to get reimbursements from their spending accounts.
The Office of Personnel Management will hire a contractor to administer the flexible spending account program. OPM officials expect to have a contractor in place by spring. In May, OPM will run an open season to educate employees about the accounts and let them sign up. The accounts will be activated in July. After the initial open season, future open seasons will coincide with the annual fall Federal Employees Health Benefits Program open seasons for standard health insurance. Except in a few circumstances such as divorce, employees cannot change their flexible spending account amounts outside of open seasons.
The IRS lets people pay for the following medical expenses via flexible spending accounts. The expenses covered in the federal government's program may be different, since some of these services may already be covered by standard health insurance.
- abortion
- acupuncture
- treatment for alcoholism
- ambulance service
- artificial limbs
- artificial teeth
- birth control pills
- books and magazines in braille
- some health-related home improvements
- medical care by a chiropractor
- treatment by a Christian Science practitioner
- contact lenses
- crutches
- dental treatment, including x-rays, fillings, braces, extractions and dentures
- drug addiction treatment
- eyeglasses
- fertility enhancement
- guide dogs
- hearing aids
- co-payments and deductibles for insurance-covered care
- laser eye surgery
- insulin and prescribed drugs not covered by standard insurance
- psychiatric care
- smoking cessation programs
- vasectomies
- weight-loss programs at physician's direction
- wheelchairs
- X-ray fees
Expenses not covered by flexible spending accounts include cosmetic surgery, hair transplants, health club dues, funeral expenses and maternity clothes.
For more information about covered expenses, see IRS Publication 502 (for medical expenses) and IRS Publication 503 (for dependent care expenses).
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