New Rules for Flexible Spending Accounts

Does the new health-reform law affect any of my flexible spending account decisions during this year's open-enrollment season?

SEE OUR SLIDE SHOW: 7 Smart Uses for Your Flex-Account Money

Contributing money to a health-care flexible spending account continues to be a great way to stretch your dollars. The money you contribute to these payroll-based savings accounts escapes both federal and Social Security taxes (and in most cases, state and local income taxes, too). You can use the tax-free funds to pay out-of-pocket medical expenses throughout the year.

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Every fall, you need to make some key decisions about your flex plan, including how much to contribute to next year’s account and how to use the money remaining in this year's account before the cutoff date (if you don’t use it, you lose it). In most cases, you have until March 15, 2011, to use your 2010 funds, but some employers still adhere to the old December 31 deadline for using the money or forfeiting the balance. Check with your employer to verify your plan’s deadline.

Health-care reform has made some key changes to flexible spending accounts starting in 2011. The changes will affect how much you can contribute to these tax-advantaged accounts, how you can spend the money, and which of your family members can benefit. Here are three new rules that may affect the amount of money you decide to set aside in your account for next year -- and how you use any money left over in the last few months of 2010.

1. No more non-prescription drugs. Starting in 2011, you’ll no longer be able to use FSA money for non-prescription drugs (except insulin). And even if your employer gives you until March 15, 2011, to use up the money in your account from 2010, you still won’t be able to spend it on over-the-counter drugs without a prescription after December 31, says Sunit Patel, senior vice-president of Fidelity Investments Benefits Consulting. Keep this in mind as you plan your FSA spending for the last few months of the year.

Also, ask your doctor if you can get a prescription for any over-the-counter medications you use regularly, such as pain relievers, allergy medications, anti-fungals, and cough and cold medicines, says Jody Dietel, of WageWorks, which administers FSAs for employers. Starting in 2011, you’ll need to submit a prescription along with a receipt (or a receipt listing the Rx number) to your FSA provider in order to get reimbursed for the medication from the account. And there are penalties for skirting the rules. If you use your FSA money to buy non-qualifying medical expenses, the amount will be included in your gross income and subject to an additional tax of 20%.

2. New rules for adult children’s expenses. FSAs have always allowed liberal coverage for children -- you could use the money for any dependent child’s medical expenses, even if that child was not covered by your health-insurance plan. So even if your child had coverage through your spouse’s plan or another insurance provider, you could still use the money in your FSA for their out-of-pocket costs (but not to pay for health-care premiums). In the past, you could use the FSA money only if your child was considered a dependent for tax purposes. But most employers have expanded the definition of dependent to include any child who is younger than 27 at the end of the year, even if he or she isn’t claimed as a dependent and doesn’t live at home.

Before deciding how much to set aside for next year’s medical expenses, ask your employer which of your family members are eligible to use FSA money in 2011. And find out whether this change applies in 2010, too. A few plans have already implemented the new rules, which means you may have more options for putting your money to use by this year’s deadline.

3. Lower FSA limits in the future. FSA limits aren't changing in 2011 -- many employers will allow contributions up to $3,000 or $4,000 in the account. But the maximum limit will shrink to $2,500 in 2013. So if you’re considering a costly elective medical procedure that isn't covered by insurance -- such laser eye surgery or a major dental procedure -- you might want to schedule it in 2011 or 2012 so you can stockpile more pretax money in your FSA account.

If your employer offers a grace period until March 15 of the following year to use up the previous year's FSA money, there's a sweet spot in the first few months of the year when you can double up your available funds, using any money left over from the previous year combined with the current year’s FSA allocation. See Saving Grace Period for Flex Account for details.

For more information about the upcoming changes to FSAs, see What Health Reform Means to FSAs and HSAs. And for a preview of how your health-insurance options may be changing in 2011 and for advice on open enrollment this fall, see Health Insurance Changes for 2011.