Strategy # 17: BIG SAVINGS on your medical, transportation, and child care expenses!

As you know, some sales are just gimmicks. On the other hand, the “sale” above is never promoted but one you need to get in on. If your employer offers spending (sometimes called reimbursement) accounts, take advantage. Through these plans you save the equivalent of your top tax rate multiplied by all your spending eligible for reimbursement.

You: What does that mean?

Think about reimbursement accounts as a series of straightforward steps.

1. You enroll.
2. You contribute your own money to your account. (You determine the amount. There may be a minimum and a maximum permitted annually.)
3. You incur an expense eligible for reimbursement.
4. You request reimbursement from your account.
5. You receive a reimbursement check.
6. Money remaining in your reimbursement account is typically forfeited at the end of the year.

You: Why should I do this? Seems like a bunch of work just to move money around. Besides, I have no idea how much money I’ll spend on stuff eligible for reimbursement, so I could end up forfeiting money! I can’t afford that. No thanks. I’ll just pay these expenses as they come up.

You’re right—forget it.

You: Really?

No.

You: Then tell me how a spending account could make any sense for me. Or anyone.

There’s one key factor making reimbursement accounts worth considering: The contributions put in the spending account are pre-tax but the reimbursements are post-tax.

You: You said this was going to be straightforward. What are you talking about?

Let’s take an example. Say you participate in a health care reimbursement account by putting $10 each paycheck into the account. Since you are paid every two weeks, you contribute $260 during one year from 26 paychecks.

Each $10 contribution reduces your gross pay. Assuming your tax withholdings are 25 percent of your gross pay, your tax withheld decreases by $2.50. Overall, your net pay decreases by $7.50.

If you pay $260 (or more) of reimbursable expenses throughout the year and complete the reimbursement form, you will receive a check for $260.

Review what happens.

1. You divert $260 of pay before tax to your spending account.
2. You pay $260 in medical expenses from your after-tax income.
3. You receive $260 back from your spending account.

Note that numbers one and three cancel each other out. Number two happens regardless of whether you participate in the spending plan. Next comes number four:

4. Your tax decreases by $2.50 per paycheck or $65 for the year.

You are $65 richer by going through this process. No games, no gimmicks. You’re basically taking money from one hand, giving it to another, and taking it back again. And by doing so, you permanently save tax. The more you contribute and the higher your income tax rate, the more you save.

Still not sold? Here’s another way to look at it:

Wouldn’t you take advantage of a coupon for 25 percent off even if you had to complete some forms? That’s exactly what you accomplish if your top tax rate is 25 percent!

The primary drawback of a spending account is that you must typically use all your contributions to the plan in the year you make them. If you don’t, you forfeit the amount of money by which your contributions exceed your eligible spending. Therefore, don’t contribute more money to the plan than you reasonably expect to spend.

You: Does that mean I need to predict the future?

Sort of.

You: Sorry, but my time machine is at the shop.

Mine too. The risk of forfeiture causes many people to simply ignore the opportunity spending accounts provide. However, the best thing to do is to look over your records from the previous year or two and estimate your reimbursable expenses. Use an annual total as an indicator of the amount you might spend in the future. Think about expenses that can be reasonably predicted. At a minimum, put that amount in your account.

Consider the risk of forfeiture of unused funds when determining the amount to put in your accounts, but take advantage of these plans. The extra paperwork and recordkeeping are worth the effort.

Reimbursement accounts are one way to increase your ability to save, your ability to live Beyond Paycheck to Paycheck, without lowering your standard of living one bit. It’s an example of not being cheap, but being fiscally responsible.

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