PLANNING Don't Fear the Use-it-or-lose-it Rule by Kevin McCormally
This is the time of year millions of employees are asked to sign up for reimbursement plans at work to pay for child care and medical bills. And far too many of us take far too little advantage of this terrific fringe benefit.
The beauty of these plans is that they let you pay your bills with pre-tax dollars. Salary that goes into the plans dodges federal income and social security taxes and, in all states but New Jersey, state income tax, too. Put $5,000 into a plan to pay child care bills that you have to pay anyway, for example, and you might save you $2,000 or more in taxes.
But many employees are leery of these plans because of the use-it-or-lose-it rule. You have to decide up front how much to put in the plan and if you don't spend it all within a year, the leftover amount is forfeited.
That sounds dangerous. But the tax breaks are so great that you can -- and should -- be aggressive when deciding how much to put in your account. Sure, you don't want to forfeit a single dime. But remember this: The savings are so powerful that even if you wind up forfeiting 20% of what you put into a plan, you'll still come out ahead.
Say you set aside $5,000 for medical expenses in 2005 and wind up spending just $4,000. You lose $1,000. Ouch! But think about this: If you're in the 25% federal tax bracket and face a 5% state income tax as well as the 7.65% social security and medicare tax, running $5,000 through the plan saves you more than $1,800 in taxes. Or, put another way, you'd have to earn almost $6,300 to have $4,000 leftover to pay those bills. So, even if you forfeit $1,000 you come out ahead.
Use our calculator to find out how much you should put in your flexible spending account. It's better to be prepared for unanticipated expenses than to skimp on what you set aside.
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