Flexible Spending Accounts

That pre-tax contribution is a big benefit, since your contributions are not subject to income taxes or payroll taxes. So if you contribute $5,000, that may translate to savings of $1,500 or more in taxes each year.

The major drawback? Here’s a hint: The plan’s motto should be “Use it or lose it.” Any portion that you don’t spend by year end on specified expenses is forfeited. And if you are laid off, you not only lose your job, you can lose your unspent contributions as well.

To counter part of that drawback, since 2005 employers have been authorized to add a grace period to their plans, giving employees until March 15 of the following year to spend their flex-spend contributions. And once over-the-counter medications were added to the list of eligible expenditures in 2003, employees who still had a balance in their account could stock up before the grace period expired.

Kiss that benefit bye-bye. Beginning in 2011, over-the-counter medications can’t be reimbursed from a flex-spend account. So don’t count on cleaning out your account at the end of this year by stocking up on cold and allergy medications, vitamins, sunscreen and aspirin. But pssst, here’s a little secret. There are several exceptions to this rule:

• If you have a doctor’s prescription, the medication is eligible for reimbursement even if it is over-the-counter. So ask your doctor for formal documentation for any over-the-counter medicine he or she recommends. Your doctor may object because it’s more paperwork, but it will save you money, so push for the prescription anyway.
• Insulin is covered, even if it is purchased without a prescription.
• Also covered are other expenses such as medical devices, eye glasses, contact lenses, co-pays and deductibles.

Okay, you say, I can live with those changes, as long as I get to enjoy that big fat $5,000 a year pre-tax benefit. Oh, sorry, here’s some more bad news: beginning in 2013 your annual contribution limit will be $2,500, only half of the amount allowed by most employer plans currently. To ease your pain a bit, this cap will be adjusted annually for inflation.

Why are they doing this to us? These changes are part of the new health law legislation that is phasing in over the next few years. Congress felt that employees wouldn’t need flex-spending accounts once health care coverage was more affordable and comprehensive. And besides, limiting the tax break helps the government muster the revenue it needs to finance the health care overhaul.

Most employees don’t take full advantage of flex-spend accounts, and the average contribution is only $1,400 or so. But if you contribute more heavily, you will definitely be affected by the upcoming change in contribution limits. With the new $2,500 maximum contribution limit coming up, consider scheduling any big medical procedures for the upcoming year, such as Lasik eye surgery, elective dental work or braces. That way, a big chunk of those expenses can be paid with pre-tax money.

1. Consider Life and Disability Insurance

From diapers to diplomas, the cost of raising a child can really add up. If something awful were to happen to you or your spouse, life and disability insurance offer a safety net to keep your loved ones’ financial lives on track. You can get an estimate of your insurance needs by using the online calculators at the non-profit Life and Health Insurance Foundation for Education (LIFE).

2. Build an Emergency Savings Fund

You never know when your roof will spring a leak or when the job market will turn sour. Keeping six months of income in a savings account or money market fund can help weather life’s inevitable pitfalls. Try setting aside money at the beginning of the month, not the “extra” at the end – there’s rarely any extra!

3. Start Saving for College

Your baby may not even be crawling yet, but with college costs rising 40% in the last decade, it’s a good idea to start saving early. Consider opening a Section 529 college savings account. As long as you use the account for qualified higher education expenses, all distributions will be tax-free.

4. Let your employer help

Many employers offer flexible spending accounts which allow you to set aside thousands of dollars in pre-tax income to pay for qualified childcare and healthcare expenses. Depending on which tax bracket you are in, using these accounts can save you thousands of dollars a year.

5 . Claim the child care credit

Your baby brings a new dependent deduction for your tax return, but other benefits are available as well. Though child care is expensive, Uncle Sam can help take the sting away with a tax credit. If you work and pay for child care, until your child turns 13, you can claim up to 35% of the first $3,000 of expenses ($6,000 for two or more children). Nursery school, private kindergarten, after school programs and day care are all qualifying expenses.

The financial stakes rise considerably when you bring a new child into the world. As you travel the road to financial security, be sure to take time to enjoy your new baby!

Click here for more tax tips for new parents.