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Flexible Spending Accounts: Definition & Eligibility

Instructor: Ian Lord

Ian has an MBA and is a real estate investor, former health professions educator, and Air Force veteran.

Flexible spending accounts offer a valuable tax break on healthcare expenses. However, it helps to be aware of the rules about these accounts and what expenses are eligible for this tax treatment.

Flexible Spending Accounts

No one wants to pay more in taxes than they have to. Fortunately, there is a way to save on taxes by paying for certain expenses that you probably would have paid anyway. If you have the ability to use a flexible spending account, also commonly known as a flex account, it's possible to take advantage of these savings. Let's look at what a flex account is, how it works, and what kind of expenses can be covered in these plans.

Definition

Many employers set up a flexible spending account program, which allows employees to optionally place a portion of their income into a special account that can be used to pay for eligible healthcare expenses. In exchange for restricting this money to eligible expenses, the funds are no longer taxed by the federal government and many state governments. The employees' savings are the taxes they don't have to pay on this income.

Account Rules

As of 2016, funds totaling $2,550 can be placed into a flex account each year. For a married couple, each spouse may have his or her own flex account and make these contributions. Employers may contribute a portion of this money, but typically, most of the amount is deducted from the employee's paycheck.

Generally, any money placed in a flex account must be spent by the end of the calendar year, or it is lost. However, an employer may choose to pay for one of two options to help: employees may be able to carry over $500 of unused funds to the next year or have an additional grace period of two-and-a-half months to use the remaining balance. Employers are not obligated to offer either of these options, and only one option may be used in the plan.

Flex account expenses can typically be paid in two ways. Many accounts include a debit card that can be used directly to pay for the expenses. A slower option is to submit receipts after paying with cash, check, or a personal credit card and apply for reimbursement. In either case, it's important to save receipts since the flex account may demand proof that expenses are, in fact, eligible.

Eligible Expenses

So what kind of expenses can be paid out of a flex account? The general rule is that most out-of-pocket costs other than insurance premiums, which are paid monthly in order to maintain the policy, are eligible. Deductibles and copayments paid at the doctor's office are eligible expenses, as are the costs for any prescription medications. Flex accounts can also be used to pay for dental work expenses. Medical equipment ranging from bandages to crutches and blood pressure monitors can also be bought with flex account funds. These expenses are directly related to treating, curing, or preventing disease and not simply beneficial to general health.

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