When people have a chance to cut their taxes, they often are
willing to jump through all sorts of hoops in order to take
advantage. But some coming changes to a major tax break that
millions of workers benefit from could dramatically reduce the
amount of tax savings you enjoy.
Flex your money muscles
The tax benefit in question is the
flexible spending plan
, also known simply as flex plans. If your employer offers a flex
plan, then every year, you're allowed to set aside a certain amount
of money toward out-of-pocket medical expenses for that year.
How it works is simple. Depending on the amount you elect to set
aside, your employer will withhold a certain amount from each of
your paychecks over the course of the year. In exchange, when you
have eligible medical expenses, you're allowed to take the money
you've set aside out of your flexible spending account. In other
words, the flex plan acts as an aid to help you budget for medical
expenses throughout the year.
But the true benefit of flex plans comes from the tax
advantages. Flex plans allow you to
save pretax money
toward those medical expenses. You don't even have to pay Social
Security and Medicare taxes on the money you put in your flex plan.
On the other end, when you spend money from your flex plan, you
don't have to pay taxes on it. So if you're in the 25% income tax
bracket, putting $1,000 in a flex plan could save you $250 in
income tax, plus another $76.50 in Social Security and Medicare
taxes. That's a valuable benefit.
Changes are coming
Unfortunately, the health-care-reform law changed the rules for
flexible spending accounts. Beginning next year, you can no longer
use flex plan money to buy over-the-counter drugs or medicines
unless a doctor has specifically prescribed them.
That's bad news for many of the companies that produce the
over-the-counter drugs that the new law excludes.
Johnson & Johnson
) , for instance, sold $438 million in over-the-counter medicines
and nutritional products during the third quarter of 2010, and that
was down sharply because of
numerous product recalls
. Other big brands come from
Procter & Gamble
) , and
Moreover, even non-name-brand companies could feel the bite.
) , for instance, is the largest producer of store-brand generic
over-the-counter drugs for companies that include both general
) as well as drugstore chains
But investors shouldn't necessarily expect a huge hit to the
bottom lines of these companies. That's because most people who
participate in flexible spending plans use their money for
prescription drugs rather than over-the-counter products, according
to HR consulting firm
Perhaps more importantly, a number of over-the-counter products
are exempt from the new provisions. In particular, vision products
such as eyeglasses and contact lens solution, as well as bandages,
dental care products, and even insulin for diabetics will still be
eligible for reimbursement under the new flex plan guidelines.
What to do
So instead of overreacting to the changes in the rules, take a more
measured approach. It's always a challenge to try to anticipate how
much money you'll need for medical expenses in a given year.
Because you forfeit unused flex plan money, however, you don't want
to set aside any more than you're certain you'll be able to
The bigger change to flexible spending plans will come in 2013,
when a new maximum of $2,500 will apply. But that's not something
you need to think about in considering how much to set aside next
Unless you spend an extraordinary amount on over-the-counter
drugs, it's likely that you'll need to reduce your flex plan
election by only a small amount to reflect reduced eligibility
under the new rules. That may cost you a few dollars at tax time,
but you'll still be able to get a huge tax break from participating
in your flex plan.
Making the most of all of your employee benefits is crucial
for your financial health.
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