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Chapter 3: Flexible Spending Accounts and Transportation Savings Accounts

Retirement and education plans offer you tax breaks for saving for expenses you will typically incur far in the future. However, you may also be able to get tax breaks on expenses you have today.

Medical Expense Flexible Spending Account
Offered through employers, a medical expense flexible spending account is a savings plan that allows you to contribute earnings pre-tax and withdraw the funds to pay for qualified unreimbursed medical and dental costs, such as co-pays for office visits and prescription medication. Unlike with retirement plans, you do not have to pay taxes on the withdrawals. The example below shows the benefits of contributing to a flexible spending account.

Let’s say you have a marginal state and federal income tax rate of 30% and your unreimbursed health costs average $2,000 a year. You decide to set aside $1,600 a year in a medical expense flexible spending account. This will save you $480.

You can sign up for a flexible spending account during your employer’s open enrollment period. At that time, you must choose how much you want deducted from each paycheck. Your first instinct may be to contribute as much as possible to take full advantage of the tax break, but keep in mind that flexible spending plans operate under a “use it or lose it” rule – any money not spent by the end of the year is forfeited. Many financial experts recommend that you set your contributions at 80% of your anticipated health care costs.

If you have a high deductible health care plan, you may qualify as for a health savings account. It works the same way as a flexible spending account, and an added bonus is that you don’t lose unspent balances at the end of the year. You can sign up with your employer, if you have insurance through them, or, if you pay for your insurance on your own, at many financial institutions.

Dependent Care Flexible Spending Account
While the medical expense flexible spending account allows you to use pre-tax dollars to pay for medical expenses, the dependent care flexible spending account allows you to use pre-tax dollars to pay for – what else? – dependent care. In order to take advantage of this account, you and your spouse (if applicable) must work, and the funds can only be used to pay for dependent care expenses while you are working. You can’t use it to pay the babysitter when you go to the movies! However, you may be able to use it to pay for summer day camp. The dependent does not have to be a minor child; it can also be a parent who is incapable of caring for him or herself. If you are interested in opening up a dependent care flexible spending account, talk to your human resources department.

Expenses paid through a dependent care flexible spending account cannot be used to claim the child and dependent care credit. You may want to talk to a qualified tax advisor about what would provide the biggest tax benefit in your situation.

Transportation Savings Account
A transportation savings account is a benefit offered by many employers that allows you to use your pre-tax dollars to pay for qualified transportation expenses. Qualified expenses include parking (near your place of work or commute site, not near your home), public transportation, and vanpooling (vehicle must seat at least six, and at least 80% of usage must be for transporting employees to and from work). If you drive yourself to work, you cannot use a transportation savings account to purchase gasoline.

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