Section 125 is a part of the Internal Revenue code that allows employees to trade taxable salary dollars for non-taxable benefits. Allegheny College’s Section 125 Plan/Flexible Spending Account allows you to pay for certain health care and dependent care expenses on a pre-tax basis.
IRS Section 125/Flexible Spending Account
IRS Section 125/Flexible Spending Account Options
How Section 125/Flexible Spending Accounts Work
Who is Eligible?
Why Two Accounts?
How Many Pre-Tax Dollars am I Allowed to Spend?
Further Regulations Under Dependent Day Care IRS Regulations
Getting Money Out of Your Spending Account
But Use It or Lose It
Should You Open a Section 125/Flexible Spending Account This Year?
Spending Account Decision Maker
Spending Account Worksheet
How You Can Enroll
Eligible Health Care Expenses
Statement of ERISA Rights
A Flexible Spending Account (FSA) is an employer-sponsored plan that lets you deduct dollars from your paycheck and put them into a special account that’s protected from taxes. FSA accounts are exempt from federal income taxes, Social Security (FICA) taxes and, in most cases, state income taxes. The more money you put in, the more tax you avoid. When you use the money in your account to pay for out-of-pocket family care expenses, you avoid paying taxes on those dollars. Depending on your tax bracket, you will probably save one-third or more on out-of-pocket family care expenses.
With Section 125 Spending Accounts, you can use pre-tax earnings to pay for two types of expenses: (1) dependent day care costs, in or out of your home; or, (2) health care expenses like medical plan co-pays, deductibles, or other expenses that are not covered under your health insurance plan.
You can participate in either or both of these accounts. They’re as easy to use as a bank account: you deposit money in your account(s) throughout the year and then make withdrawals to reimburse yourself for out-of-pocket health and dependent day care expenses. The difference is, the money in your Spending Accounts is not subject to Federal or Social Security taxes — and, in some cases, state-income taxes — when it goes in or when you receive reimbursement.
In effect, you pay your expenses with pre-tax money, which means you pay less for many routine health and dependent day care services.
Your actual savings depend on how much you decide to put into your account and what your tax rate is. Here are some examples of some predictable expenses and how much you would save if they were paid through a Section 125 Plan/Flexible Spending Account. These examples assume 15% or 28% federal income and 7.65% Social Security tax rates.
|For these expenses …||You’d save about this much in taxes at a|
|22.65% tax rate …||35.65% tax rate …|
Day Care $2,500
Medical Deductible 400
Eligible individuals are full-time (minimum nine months per year) employees who work at least 33 and 3/4 hours per week, effective the first day at the beginning of the new plan year. Eligible employees may participate in:
- The Pre-Tax Premium Plan on the date the employee becomes eligible for insurance benefits.
- The Flexible Spending Account on the date the employee becomes eligible under the plan.
The IRS requires that you have separate Spending Accounts: one for health care and the other for dependent day care. You can open one type of account and not the other, or open both kinds of accounts; however, there are some general rules set up by the IRS which you must follow in exchange for the tax advantage it gives you.
- The only time you can make a change in your account contributions is during open enrollment once each calendar year, or when you have a change in family status like a marriage, divorce or the birth of a child.
- You cannot transfer money between accounts.
- The IRS requires that you forfeit any unused deposits at the end of the year.
|Health Care Spending Account||Dependent Day Care Spending Account|
|For co-pay, out-of-pocket medical, dental and vision care expenses, not covered by any plan, such as:||For dependent day care needed to allow you and your spouse to work, to look for work, or to attend school full-time such as:|
|Medical co-pay (in network), deductibles/out of pocket (non-network)Eye exams, glasses, contactsDental visitsHearing care and hearing aids||Day care at home day care centersNursery schools|
Health Care Flexible Spending Account
$2500 — maximum annual contribution
$0 — minimum annual contribution
Dependent Care Flexible Spending Account
$5000 — maximum annual contribution (regardless of the number of dependents)
$2500 — maximum annual contribution for married individuals filing separately
$0 — minimum annual contribution
For purposes of the Dependent Day Care Spending Account, the IRS defines a dependent as anyone you claim as a deduction on your income tax:
- who is under age 13; or
- who is mentally or physically disabled, including a disabled child or spouse in your care.
NOTE: “Dependents” must spend at least eight (8) hours a day in your home.
NOTE: If you are divorced and have custody of your child, he or she may qualify as a dependent even if you do not claim a deduction for that child on your income tax return. (Discuss this with your tax consultant.)
You can use the Dependent Day Care Spending Account to pay for dependent day care you could otherwise claim on your tax return, including care provided:
- inside your home by a day care provider who is not your dependent; or
- outside your home by a day care center, day camp, nursery school or other qualified caretaker.
You cannot use the account to pay for services that the IRS does not recognize as “qualified”. Some expenses that are not qualified by the IRS are:
- care provided by a spouse or a dependent under age 19;
- care provided for non-work-related reasons;
- any dependent day care services provided if your spouse does not work, unless your spouse is a full-time student; or
- any expenses you plan to deduct on your income tax return.
Also, the IRS requires that you submit your day care provider’s name, address and Social Security number or tax identification number in order to receive reimbursement from a Dependent Day Care Spending Account. You can obtain this information by asking your dependent day care provider to complete IRS Form W-10.
The Dependent Day Care Spending Account may be the best way for you to save taxes on dependent day care expenses. However, you will also want to consider whether taking a dependent day care tax credit on your federal income tax return saves you more in taxes. (Discuss this with your tax consultant.)
Payment of your Section 125 reimbursements for medical and dependent care expenses will be processed by ADP FlexDirect. Your claims can be faxed or mailed to ADP. If you submit claims via mail, send COPIES only and not original receipts. Keep all original receipts.
The Health Care Account and the Dependent Care Account are separate accounts. Funds cannot be transferred from one account to the other. Eligible claims must be incurred during the plan year stated above or during the period of the plan year that you are actively participating. According to current IRS rules, an expense is considered incurred when service is actually received, not when you are billed or pay for the service.
This kind of plan is governed by the IRS regulations. The IRS requires that you forfeit any unused deposits at the end of the year. Balances can not be rolled into the next year.
You have 90 days following the plan year to submit claims that you incurred during the previous plan year. You have 90 days following your termination from the plan to submit claims incurred while you were participating.
Paying predictable expenses through a Spending Account can save you a lot of money, but you need to estimate your expenses carefully based on your other benefit decisions. Here are examples of what two employees – Joe and Pam – might consider in their decision.
Example 1: Joe has spent $135 on medical care this year. If he has similar expenses next year, he’ll pay this amount towards his deductible under his medical plan. He doesn’t have dental coverage but anticipates needing routine cleanings and exams which will cost about $70. Since his combined federal and Social Security tax rate is approximately 22%, Joe can save about $45 by running this $205 in expenses through a Health Care Spending Account.
Example 2: Pam pays $3,000 a year in day care for her two kids. In addition, she expects that one of them will need braces which will cost her about $500 in out-of-pocket expenses for the year. At a tax rate of 22%, Pam will save almost $770 by paying this $3,500 in expenses through the Spending Accounts. Keep in mind that she has to open separate Spending Accounts: one for health care and the other for dependent day care.
Your answers to the following questions may also help guide you to a decision about Section 125 Spending Accounts.
- How much did you pay out-of-pocket for health care or dependent day care expenses last year?
- What dental expenses do you expect to incur in the upcoming year?
- What expenses do you expect to incur in the coming year that are not covered by your health insurance plan?
- Do you or your dependents need glasses, contacts or eye exams?
This on-line worksheet is designed to help you estimate how much you should contribute to a Health Care Spending Account and/or Dependent Day Care Spending Account. Once you’ve determined how much you need to cover your expenses, fill in that amount on your enrollment form. Remember that the IRS limits your opportunities to stop, start, increase or decrease your contributions during the year unless you have a change in family status, and any money left in your account(s) that can’t be used for the year’s expenses will be forfeited. For these reasons, it’s important to estimate carefully.
Now that you’re familiar with your Section 125 options, it’s time to make your decisions!
If you’re still unsure of which options are best for you, here’s a checklist of things to do to help you make the most effective benefit choices:
- Review your brochure for details on any benefit you are considering so you are sure you understand it completely.
- Review the examples and Decision Maker sections again to help make sure your choices meet your needs.
- Use the Section 125 Spending Account worksheet to carefully estimate your health care and dependent day care expenses and Spending Account contributions.
Under IRS regulations, once you have enrolled in a Flexible Spending Account, you may not change your election except in the case of a specific regulatory exception. The most common of these exceptions are the Changes in Status and Cost and Coverage Changes exceptions, outlined below (Other exceptions include events relating to HIPAA, a judgement, decree or order regarding payment of health insurance or child care, entitlement to Medicare or Medicaid, qualified adoption assistance and the FMLA, but these are outside the scope of these highlights).
Election Changes based on a Change in Status
(allow changes to both health and dependent care flexible spending account elections)
Any election change must be made on account of and correspond with a change in status event (listed below) that affects eligibility for coverage In the case of a dependent care FSA only, the change in status event may affect your dependent care expenses or eligibility for coverage, which means that it will be easier to make changes.
- Legal Marital Status: marriage, death of spouse, divorce, legal separation, annulment
- Number of Dependents: birth, death, adoption, placement of adoption
- Employment Status: with respect to the employee, spouse, or dependent, a termination or commencement of employment, a strike or lockout, commencement or return from unpaid leave of absence, a change in worksite, or similar circumstances
- Dependent Satisfies or Ceases to Satisfy the Eligibility Requirement: student status, dependent no longer qualifies because of age, or similar circumstances
- Residence: change in place of residence of employee, spouse or dependent
- Adoption Assistance: commencement or termination of an adoption proceeding
Election Changes based on Cost or Coverage Changes
(allow changes to dependent care FSA elections only; these do not apply to a health FSA election)
- You may change your dependent care FSA election amount if the provider changes the cost of the care, so long as the provider is not your relative.
- You may change your dependent care FSA election if you change providers and the new provider charges more (or less) for care
- You may change your dependent care FSA election amount if you begin or stop sending your dependent to day care.
You must notify your plan administrator within 31 days of the event permitting the election change. If the election change is made, it will become effective on the latter of:
- The first of the month following the date the change is status event occurs (if you plan ahead); or
- The first of the month following the date the request form is signed (if you sign the form after the event).
Click here for a list of eligible health care expenses.
As a participant in this plan you are entitled to certain rights and protections under the Employee Retirement Income Security Act of 1974. ERISA provides that all plan participants shall be entitled to:
(i) Examine, without charge at the plan administrator’s office and at other locations such as work sites and union halls, all plan documents, including insurance contracts, collective bargaining agreements and copies of all documents which the plan filed with the U.S. Department of Labor, such as annual reports and plan descriptions.
(ii) Obtain copies of all plan documents and other plan information upon written request to the plan administrator. The administrator may make a reasonable charge for the copies.
(iii) Receive a summary of the plan’s annual financial report.
In addition to creating rights for plan participants, ERISA imposes duties upon the people who are responsible for the operation of the employee benefit plan. The people who operate our plan, called “fiduciaries” of the plan, have a duty to do so prudently and in the interest of you and other plan participants and beneficiaries.
No one, including your employer, your union, or any other person, may fire you or otherwise discriminate against you in any way to prevent you from obtaining a welfare benefit or exercising your rights under ERISA. If your claim for welfare benefits is denied in whole or in part, you must receive a written explanation of the reason for the denial. You have the right to have the plan review and reconsider your claim.
Under ERISA, there are steps you can take to enforce the above rights. For instance, if you request certain materials from the plan and do not receive them within 30 days, you may file suit in a federal court. In such a case, the court may require the plan administrator to provide the materials and pay you up to $100 a day until you receive the materials unless the materials were not sent because of reasons beyond the control of the administrator.
If you have a claim for benefits which is denied or ignored, in whole or in part, you may file suit in a state or federal court. If it should happen that plan fiduciaries misuse the plan’s money, or if you are discriminated against for asserting your rights, you may seek assistance from the U.S. Department of Labor, or you may file suit in a federal court. The court may decide who should pay court costs and legal fees. If you have any questions about your plan, you should contact the plan administrator. If you have any questions about this statement or about your rights under ERISA, you should contact the nearest Area Office of the U.S. Labor-Management Service Administration, Department of Labor.
The College reserves the right to change, modify, or terminate this program at any time. As IRS regulations change, the parameters of the plan must also change in order to be in compliance. This booklet is intended to explain to employees the highlights of the plan in an easy-to-understand fashion. In the event of any inconsistency between this booklet and the actual provisions of the IRS code, the actual text of the code shall prevail.