For most of us, the economy is still less than great and conserving cash remains a high priority.
One easy way to keep more in your pocket is by taking full advantage of tax-saving opportunities at your job. It’s almost time to sign up for open enrollment for 2014. Here’s what you need to know to about three options that can painlessly increase your monthly cash flow by reducing your taxes.
Health care flexible spending account
Under an employer-sponsored health-care flexible-spending-account plan, or FSA, you make an election this year to contribute a designated amount of next year’s salary to your personal FSA, up to a maximum of $2,500.
The contribution is withheld in installments from your 2014 paychecks. You can then use the health-care FSA money to reimburse yourself for uninsured medical expenses, such as insurance deductibles and copayments, prescriptions, and dental and vision care.
The total amount withheld from your pay is treated as a salary reduction for federal income-tax, Social Security tax and Medicare tax purposes, and usually for state income-tax purposes, too. Reimbursements from the FSA are tax-free.
The health-care FSA allows you to pay for all or a portion of your 2014 out-of-pocket medical costs with pretax dollars. That is the same as getting an income-tax deduction combined with a reduction in your Social Security and Medicare tax withholding. But you must enroll in your company’s FSA plan to benefit, and the deadline to sign up for 2014 will be here soon.
The only downside of FSA is the “use it or lose it” rule. Generally, if you fail to incur enough qualified expenses to use up all your health-care FSA balance each year, any leftover balance reverts to your employer.
However, there are two exceptions. First, your company plan may allow a 2½-month grace period to incur enough expenses to use up your remaining balance. Second, the Internal Revenue Service announced on Thursday that employers can amend health-care FSA plans to allow you to carry over an unused balance of up to $500 to use the following year.
Plans can’t offer both the 2½-month grace-period deal and the $500 carry-over privilege. It is one or the other. In any case, you should carefully estimate your expected health-care expenditures before deciding how much to contribute for 2014.
Dependent care flexible spending account
Many FSA plans are also set up to reimburse employees for qualified dependent care expenses, which means costs to care for an under-age-13 dependent child, a disabled spouse, or a disabled person for whom you provide over half the support. The dependent care expenses must be necessary in order for you to work, or for both you and your spouse to work if you are married. The annual FSA contribution cap for dependent care expenses is $5,000 (or $2,500 if you are married and file separately from your spouse). If you are married and file jointly, the $5,000 cap represents a combined maximum for both you and your spouse.
The total amount of dependent care FSA contributions withheld from your paychecks for the year is treated as a salary reduction for federal income tax, Social Security tax, and Medicare tax purposes (and usually for state income tax purposes as well). Reimbursements from the FSA are tax-free. So, once again, this benefit allows you to pay expenses with pretax dollars, which puts extra cash in your pocket. Also once again, the tax savings are permanent, but you must sign up during the upcoming open enrollment period to benefit.
Note that the “use-it-or-lose-it” rule also applies to dependent care FSAs, so make sure you don’t contribute more than the qualified expenses you expect to incur.
Finally, your employer may also allow you to sign up to reduce your 2014 salary to pay for transit passes, van pooling, and parking to get to and from work.
• The maximum monthly amount you can set aside in 2014 for transit passes and van pooling (separately or together) is currently $130, but there is a good chance that Congress will increase the monthly limit to $250. Stay tuned.
• The maximum monthly amount for parking in 2014 is $250, and that amount is for certain.
• If you sign up for both deals (say for the train to go to and from work and for parking at a park-and-ride lot near your home), you can combine the two limits and set aside up to $380 per month, or up to $500 if Congress increases the allowance for transit passes and van pooling.
As with the FSA, the total amount withheld from your 2014 paychecks will be treated as a salary reduction for federal income tax, Social Security tax, and Medicare tax purposes (and usually for state income tax purposes as well). So this deal allows you to pay expenses with pretax dollars, which puts extra cash in your pocket every month.
The bottom line
Surveys repeatedly show that most folks fail to participate in these employer-sponsored tax-saving arrangements, often because they figure the tax savings don’t really add up to that much. This is not true.
For example, if your combined federal and state income tax rate for 2014 will be 33%, and you sign up to reduce next year’s salary by a total of $12,060 ($2,500 for healthcare FSA contributions, $5,000 for dependent care FSA contributions, and $4,560 for monthly transit passes and parking). Your income tax savings would be $3,980 ($12,060 x 33%), and your Social Security and Medicare tax savings could be as much as $923 ($12,060 x 7.65%). So that works out to an extra $4,903 in your pocket, which amounts to $409 a month, just for filling out the enrollment forms. Be smart. Sign up to participate. It’s worth the small effort.
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