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Tax$ave: Unreimbursed Medical
Spending Accounts (UMSA)


An Unreimbursed Medical Spending Account (UMSA) allows employees to save taxes on out-of-pocket medical and dental expenses that reduce spendable income.  Contributing money to the UMSA can result in a reduction on taxes because the money contributed to the account is free from federal income, Social Security, and Medicare taxes and remains tax-free when it is received.

Under this plan, up to $2,500 of salary may be set aside on a before-tax basis in a health care spending account each calendar year. The member and eligible dependents can be reimbursed for eligible expenses incurred during the year. Eligible expenses include co-payments, deductibles for medical, prescription and dental bills; expenses for medical services not covered by health plans or State vision coverage, such as contact lens solution, hearing aids, etc.; and any other health care expense that can be legally deducted on an income tax return, except premiums for health care that are covered under the Premium Option Plan

IRS Publication #502, Medical and Dental Expenses, provides a complete list of services eligible for reimbursement. 

Since no medical or dental plan will pay for everything, members will be able to save money by using before-tax dollars to pay for these bills.

How to Decide How Much to Set Aside in an UMSA

The member must estimate how much will be spent on unreimbursed health care during the calendar year. Based on this amount, contributions will be taken out of the member's paycheck each pay period throughout the entire year.

It is very important to base estimated out-of-pocket expenses on past experience because, according to IRS code, unused contributions must be forfeited. Many who participate use conservative estimates for their UMSAs, rather than risk forfeiture of unused contributions at the end of the year.

A claim may be submitted for services performed during the calendar year at any time up until the end of March of the following year. When a claim is filed, the member will be reimbursed for up to the total amount that has been elected for contribution, whether or not the total deductions to date from payroll cover the amount of the claim.  When filing for reimbursement, the member must verify that there has been no other reimbursement from any other source.

Advantages

While the federal government offers a federal income tax deduction for unreimbursed eligible health care expenses which exceed 7.5% of adjusted gross income, the UMSA offers tax-free reimbursement on each and every dollar of eligible expenses, which may provide immediate tax savings for those who do not meet the medical expense deduction threshold.  In addition, UMSA also saves the member on Social Security and Medicare taxes, another 7.65% on every dollar.  At the same time, expenses that are reimbursed under this plan cannot be deducted from the member's federal income tax.

Very Important Note:

Under UMSA, any unused contributions remaining in an account at the end of the calendar year are forfeited.  Members have until March 31 of the following year, three months after the close of the calendar year, to file for eligible reimbursement.

Social Security Implications

Since payments to a Flexible Spending Account (DCSA or UMSA) and POP lower annual earnings against which Social Security deductions or employer contributions are made, there is a valid concern that participation in these plans would result in reduced Social Security benefits at retirement.

For a person born after 1928, the Social Security benefits are calculated using a 35-year average of earnings. A reduction of $2,000 a year or even $5,000 a year over some portion of this 35-year span would have little effect on the average salary and, therefore, minimal impact on the Social Security benefits. 

To illustrate possible Social Security implications, the Social Security Administration has provided the Division of Pensions and Benefits with an example of an employee who retired in 1998 at age 65 whose wages had been at the maximum wages subject to Social Security deductions. Upon retirement, this individual's monthly Social Security allowance was $1,343. If that same person had been contributing $2,000 a year for the last 10 years to a FSA, the subsequent reduction in Social Security wages would have produced a monthly Social Security allowance of $1,335, a difference of less than $10 per month.


Fact Sheet #44, Tax$ave, and the annual Tax$ave Open Enrollment newsletter provide additional information about Tax$ave, including the UMSA.

Additional Information about the UMSA

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Last Updated: February 22, 2006