Smart Tax Planning

You’re running out of time to use these tax-advantaged funds

Key Points
  • Flexible spending accounts or FSAs allow employees to set aside up to $2,750 in 2020 to cover health-care expenses.
  • Generally, you have to use the money by the end of the year or else forfeit the cash. Employers have the option of giving employees until March 15 of the following year to use the money or allow them to roll over up to $550 as of 2020.
  • In May, the IRS rolled out special relief for FSA plans, including giving administrators the option to permit workers to tap unused 2019 funds for expenses through 2020.
Peathegee Inc | Tetra images | Getty Images

You have just a few weeks to tap the money you've been saving for medical needs — or risk losing it.

Health-care flexible spending accounts, which your employer may offer, allow you to store pretax dollars in a special account. In 2020 and 2021, you can contribute up to $2,750.

These funds are free of tax and you can take tax-free distributions, provided the money is for qualified medical expenses, including dental care, acupuncture and prescription eyeglasses.

Of course, nothing good lasts forever.

While you can tap the money as early as Jan. 1, you generally have until the end of the year to use the funds or else you forfeit your remaining balance.

More from Smart Tax Planning:
Voters chose to legalize and tax recreational pot in these 4 states
This is the maximum you can save in your 401(k) plan in 2021
Here are the new tax brackets for 2021

The IRS gives employers the option of allowing workers to roll over some of the money into the following year  — up to $550 for 2020 — or providing them up to 2½ months after the plan year ends to spend leftover funds.

Companies aren't required to give you either choice.

To make things a little more interesting in light of Covid-19, there are also a few special rules the IRS added this year for FSA holders who haven't been spending down their accounts as quickly as they'd like.

More time to spend down

When Americans hunkered down in their homes this spring, health-care FSA holders likely put off trips to the doctor and the dentist.

The funds they rolled into 2020 from 2019 were going unused, and they stood to lose the money.

Some employers were already offering FSA savers some flexibility due to the pandemic, including stopping deferrals into the accounts, said Ed Zollars, CPA and partner at Thomas, Zollars & Lynch in Phoenix and an instructor at Kaplan Financial Education.

In turn, the IRS released guidance in May, allowing employers to update their plans and provide an extended period for workers to use untapped health-care FSA funds from 2019.

Those individuals can have until the end of this year to spend down those amounts.

VIDEO3:0103:01
How to choose your health care plan during open enrollment

This relief also applies to money tied up in dependent care FSAs — accounts where you can save up to $5,000 per year to offset the cost of care for kids under age 13.

The IRS also allowed employers to give workers the chance to modify or make elections into both types of FSAs mid-year. That means those workers could tweak their contribution amounts.

Now, for the catch: This is optional for employers.

"If the plan decides to allow it, you can spend the money down through the end of the year," said Zollars.

"Even if the IRS gives relief, the employer may not decide to adopt it," he said. "They don't have to."

Pandemic uncertainty into 2021

FatCamera | E+ | Getty Images

Here's another hiccup: The May guidance from the IRS applies to 2019 balances being carried over and used in 2020. But there's no word on whether the taxman will allow plans the option to carry forward 2020 FSA balances into next year.

"As we get to the end of December, that's when the IRS will be expected to address again that there are people stuck with money in 2020 and they couldn't cut the contributions off early enough," said Zollars.

The stakes are even higher for dependent care FSAs, as another Covid-19 wave toward the end of the year could leave parents with big balances that go unused.

"It's clear that if things got bad, and we went through shutdowns, you might have unspent childcare funds," said Zollars.

"Maybe your kid is going to childcare now, but come January the hospitals fill up, things lock down and you can't spend the money," he said.

A guidepost for open enrollment

Portra | DigitalVision | Getty Images

Normally, you might look to your prior year's spending patterns as you decide how much money to save in your health-care or dependent care FSA during benefit enrollment season.

This fall, talk to your human resources department and consider how your employer handled the IRS guidance from May.

Did your company allow workers the flexibility to adjust their FSA contributions in the middle of the year? Were workers allowed more time to spend down leftover amounts from 2019?

If not, it might be worth adjusting the amount you'll defer to these accounts in 2021.

"If your employer did not adopt these rules and you're stuck with the deferral, assume they will do the same thing next year if the issue arises," said Zollars. "You have to take it into account when you make your decision."