It’s that time of the year again to select the enrollment and elections for various employment benefits for the next year 2008.
One of the many decisions to make is whether to contribute to the flexible spending account (FSA) and the related dependent care FSA. For many people, it usually makes sense to contribute to the FSA to save on taxes if the employer offers them. In my opinion, I think enough has been written on the tax savings if one were to contribute to the FSA. So, no, this post is not on this issue; rather, the aim of this post is to examine which income earner, in a double income family, should contribute to the FSA.
In a double income family, where the couple are both working and eligible for the FSA, a common question is who should contribute to the FSA? Like most people, I used to think that the person with the higher income should bear more responsibility in contributing to these accounts. However, on closer scrutiny, I find that from the tax standpoint, this common sense is actually incorrect.
Although it seems counterintuitive, it actually makes sense for the lower-income earner to make the contributions if we take into account the social security tax income limits. This is assuming the case where one income earner has an income above the social security tax income limit and the second income earner has an income that is below the income limit. I shall illustrate why this is so with an example.
The following table is an example for a hypothetical couple for year 2008 (the social security income limit for 2008 is $102,000):
In the above example, the couple earns a income of $200,000 in total. Assuming that they both plan to maximize the 401(k) contributions and the full FSA elections, scenario 2, where all FSA deductions are made from the lower income earner, results in a lower social security tax by the amount of $620.
The reason is because every dollar deducted from the lower income earner for the FSA account results in a 6.2 cents social security tax saving; whereas no additional social security tax savings is possible with the higher income earner since the social security tax is max’ed out at the income level of $102,000 anyway.
Note that in general, the above strategy would also give state tax savings if there are certain state taxes that max’es out at a specific income level. Therefore it is worthwhile to examine these deductions and plan them accordingly.