The Under 40 Financial Planning Guide: Flexible Spending Accounts

If your employer offers a flexible spending account, you probably should take advantage of that generosity. A flexible spending plan allows you to put pre-tax money aside for child care expenses or medical related expenses that aren't covered by insurance. A premium conversion plan is a type of flexible spending plan that lets you pay for health, life and disability insurance with pretax dollars.

This is one of the best tax advantages that you can get, and I recommend that everyone take advantage of this benefit.

Here's an example of how a flex plan works. If your health insurance has a deductible of $500, you have to pay the first $500 of medical expenses for you or your family. If you are in a 31 percent tax bracket, that means that you have to earn $724 and then pay taxes of $224, to have enough money to pay the first $500 of medical expenses.

Under a flexible spending account, you could elect to put a little under $10 per week into your account to cover the $500 deductible on your health insurance. When you spend money on child care or medical expenses, you fill out a simple form and your employer reimburses you.

Participating in a flex plan would save $224 from your tax bill at the end of the year. Also, it doesn't matter if you have to spend that $500 in the first month of the year -- you can withdraw as much money as you need at any point during the year as long as you don't withdraw more than you are scheduled to contribute during the entire year.

The money can be spent on almost all child care and medical costs, including glasses and contact lenses, prescription and nonprescription drugs and supplies, deductible and co-pay amounts from your health insurance.

The only hitch is that you have to spend all of the money you put in your flex account before the year end, or you forfeit it. That means that if you contribute $1,000 to your flex plan but only use $850 during the year, you lose the $150. But if you haven't spent enough, you can always buy a new pair of glasses or an extra supply of any prescription drug to try to spend any leftover amount.

I recommend trying to estimate your ongoing medical and child care expenses and putting at least 75 percent of your estimated expenses into the plan.