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4 Tax Breaks to Consider During Open Enrollment

Nov. 4, 2016
Income Taxes, Personal Taxes, Taxes
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You may think of open enrollment season as little more than a once-a-year shot to tinker with your health insurance plan at work. But employers often put other benefits up for grabs during that time, too. If you know how to take advantage of them, you could snag some big tax savings.

Lots of fringe benefits open the door to tax credits or deductions if you’re lucky enough to get them. Most tax software can help here, but these are four open enrollment ideas that tax pros say could pay off in April.

1. Shelter income through an FSA

Flexible spending accounts allow employees to move up to $2,600 in 2017 ($2,550 in 2016) directly from their paychecks into an account just for medical expenses for themselves, spouses and dependents. That money isn’t taxed, which means someone in the 25% tax bracket could save up to $650 a year just by shifting money into an FSA and then paying medical bills out of that account.

There’s a catch, though. An FSA is a use-it-or-lose-it arrangement, says Chris Chen, a certified financial planner at Insight Financial Strategists in Waltham, Massachusetts. “You need to spend it by Dec. 31,” he says.

Anything left after that is gone, although some employers may offer a short grace period, so careful forecasting is key. That’s why you should avoid maxing out an FSA just to save on taxes, says Marguerita Cheng, a CFP and CEO of Blue Ocean Global Wealth in Rockville, Maryland. “You could be in a situation where you’re not going to spend that money,” she says.

2. Pay for day care tax-free with a dependent care FSA

FSAs aren’t just for health care; there’s often a sidekick called a dependent care FSA. “I’ve never seen one done without the other,” Chen says.

Dependent care FSAs generally work like health care FSAs but shelter more income — up to $5,000. You can use it to pay for care for a child under 13 or for a spouse or dependent who can’t care for himself or herself. That could save you up to $1,250 in taxes if you’re in the 25% income tax bracket and make the maximum contribution.

Be sure to get the paperwork right during open enrollment, though. Health care FSAs and dependent care FSAs have very different allowable expenses. Accidentally funneling money into the wrong account can be disastrous.

3. Use an HSA to pay medical bills tax-free

If a high-deductible health plan is for you, you’re likely eligible for a health savings account, one of the most tax-advantaged accounts in existence. Your money isn’t taxed going in, and it’s not taxed coming out as long as you use the money for eligible health care expenses.

In 2017, you can deduct up to $3,400 of contributions if you have individual coverage or up to $6,750 if you have family coverage. If you’re in the 25% tax bracket, that could translate to a tax savings of more than $1,600 for a family. Unlike FSAs, money in an HSA is yours forever without penalty.

But don’t use open enrollment to sign up for a high-deductible health plan just so you can get an HSA, Chen says. Even without the tax savings, families with children may be better off financially with lower-deductible plans.

4. Invest tax-free through your HSA

HSA administrators often allow account holders to invest their money in mutual funds or other products. That can mean tax-free capital gains, which can turbo-boost savings.

“If you have an HSA because you’re in relatively good health and you’re not a heavy user of the health system, in that case you should definitely invest it because you’re basically looking to use the HSA much later,” Chen says.

“You can do that for several years and you can accumulate a pretty large nest egg,” he adds. Chen says the tax savings on invested HSAs can be so attractive that some people avoid withdrawals, even if it means paying their medical bills out of another account.

Be sure to consider the account fees and the risks, though. “Typically, if you’re investing in the market, you need to have a time frame longer than three years,” Cheng says. And most people should avoid putting it all in stocks, she says.

Tina Orem is a staff writer at NerdWallet, a personal finance website. Email: [email protected].