As health care costs continue to grow, employers and employees alike are searching for ways to reduce the financial burdens they face, and many are turning to consumer-driven health plans that include flexible spending accounts.
With an FSA, employees can put away pre-tax money to use for certain out-of-pocket medical expenses, and this type of account offers employees a considerable tax advantage, says Jody Dietel, chief compliance officer at WageWorks Inc.
"Employers should offer FSAs because there are growing out-of-pocket expenses for employees, and this helps employees manage those expenses on a tax-advantage basis that benefits both the participant and the employer," Dietel says. "As employers move to higher-deductible plans or more cost sharing with employees – and that's going to continue even under health care reform – it's important that employees can do that on a tax-advantage basis."
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For employers, offering FSAs can reduce their workers' compensation obligations as well as matching on Social Security and Medicare taxes, Dietel says. Though it's hard to pinpoint exactly what the average employer saves by offering an FSA, Dietel estimates there could be about a 10 percent tax savings.
Despite the tax advantages FSAs offer both employees and employers, the Affordable Care Act introduced a provision that will place a $2,500 employee contribution cap, starting in 2013. The cash-strapped government needed ways to pay for its expensive health care reform bill, says Manisha Thakor, a personal finance expert, and placing contribution limits on FSAs was one way to do that.
"Our country needs revenue because we're in a bit of a financial pickle as a nation," Thakor says. "The government needs to raise tax revenue, and since these are tax-advantage accounts that come out of your paycheck before these funds are taxed by the federal government, FSAs are being targeted as a revenue source. The biggest benefit of the cap is to our 'beloved' government, to be blunt."
Still, both Dietel and Thakor believe the FSA cap won't affect the majority of participants. Most employers previously set FSA limits at $3,000-$5,000, with some being higher and some being lower, Dietel says. Although the new $2,500 federal FSA limit is lower than what most employers would allow, the average FSA participant contributes only $1,400 per year, and employers are still allowed to add supplementary funds to FSA accounts beyond the $2,500.
Dietel also hopes the new limit could eliminate the use-it-or-lose-it rule that prohibits employees from rolling over any leftover contributions to the next year. When there was no statutory limit, the IRS was worried people would take advantage of the tax incentives, which is why the use-it-or-lose-it rule was adopted, but this is no longer an issue.
"With the $2,500 limit, it removes the concern that the IRS had about the tax shelter, so we're hopeful that we can convince the government that it's no longer an issue and time to get rid of the use-it-or-lose-it rule," Dietel says.
In a strange way, Thakor believes this has benefited some consumers because the controversy surrounding the FSA limit has given publicity to what these accounts can do, and it may encourage more employees to take advantage of the tax incentives.
"The No. 1 benefit of the cap, to me, is it's actually stirred up some news interest, and it's making people aware of FSAs," Thakor says. "Right now, only roughly one in five people who are eligible to participate in a FSA actually do, so while everyone is very worried about the cap, I'm looking at it and seeing a benefit because it's making people more aware of FSAs. Maybe we can now get those four out of five folks who are leaving this fabulous tax savings on the table to take advantage of it."
But even though the FSA cap doesn't affect the majority of participants and it could encourage greater participation, Thakor would still like to see it removed. For participants who have serious chronic illnesses, there could be a significant financial impact, and, ultimately, health care reform was not designed to hurt those who are truly in need.
"There's debate about whether the FSA limit will stay," Thakor says. "Personally, I would like to see it lifted because the people who are hurt by it are not the people anyone intended to hurt."
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