Some little-noticed changes in the massive new health care legislation—the Patient Protection and Affordable Care Act of 2010—may affect flexible spending accounts (FSAs) in 2011.
Strategy: Fine-tune your annual allocation to a health care FSA. Your decision during the open enrollment period should reflect new restrictions on qualified expenses.
The same basic changes apply to Health Savings Accounts (HSAs), Health Reimbursement Arrangements (HRAs) and Archer Medical Savings Accounts (MSAs).
Here’s the whole story: With an FSA, you save tax by making contributions to the account. Typically, the contributions are made through payroll deductions based on your annual allocation. You can withdraw funds tax-free during the year to pay for qualified health care expenses.
For instance, if you allocate $5,000 to an FSA and your income tax rate is 35%, you save $1,750 (35% of $5,000). Contributions are also exempt from the usual 7.65% employment tax (1.45% for wages above the current base of $106,800).
Generally, any amount remaining in the FSA at the end of the year is forfeited. But an employer may provide a 2½-month grace period for this use-it-or-lose-it trap.
New rules: Beginning in 2011, FSA funds no longer can be used for over-the-counter (OTC) drugs and medications, unless specifically prescribed by a physician. For example, you can’t take a withdrawal to pay for cold or allergy medicines, aspirin and other common pain relievers.
However, you can continue to take distributions to pay for medical supplies like crutches, medical testing kits, joint supports, contact lens solutions and hearing aid batteries—even Band-Aids. Some plans allow purchases of sun screen with a protection factor (PF) of more than 30 and hand sanitizer lotions. And withdrawals for big-ticket items, such as braces and eyeglasses, are still permitted.
Finally, the new health care law specifically exempts reimbursements for the cost of insulin purchased without a prescription.
Due to the new rules, you might lower your usual allocation for 2011 if you’ve previously used FSA funds for OTC medications.
Tip: Currently, there’s no tax law limit on annual contributions, although a limit may be self-imposed. Beginning in 2013, the new law caps contributions at $2,500, subject to annual inflation adjustments.