Flexible Spending Account (FSA)

A Flexible Spending Account (FSA), also known as a Flexible Spending Arrangement, is a type of savings account that provides the account holder with specific tax advantages. This type of account is set up by an employer for employees to use to pay for various health-related expenses. Contributions to an FSA are made pre-tax, meaning that the money put into the account is not subject to payroll taxes, providing a means for individuals to save money on their health care costs and other eligible expenses.

How FSAs Work

FSAs allow employees to contribute a portion of their regular earnings to pay for qualified expenses related to medical and dental services. The maximum annual contribution limit is set by the IRS, and for the year 2023, the limit is $3,050. The funds contributed to an FSA can cover a wide range of expenses, including but not limited to:

• Prescription medications
• Medical equipment and supplies
• Doctor co-pays and deductibles
• Dental treatments
• Vision care

One of the main attractions of an FSA is the tax benefit. Since contributions are made on a pre-tax basis, they reduce the account holder’s taxable income, which can result in significant tax savings. Additionally, withdrawals for eligible expenses are also tax-free.

Types of FSAs

There are mainly two types of FSAs:

1. Health Care FSA: This is the most common type, which covers medical, dental, and vision expenses that are not paid by insurance.
2. Dependent Care FSA: This applies to dependent care expenses such as daycare for children under 13, or care for a disabled spouse or dependent which allows the employee (and their spouse) to go to work.

Limited Purpose FSA

There is also a Limited Purpose FSA, designed specifically for those who are enrolled in a Health Savings Account (HSA). This specialized FSA covers only dental and vision expenses.

Eligible Expenses

The IRS publishes a list of eligible and ineligible expenses each year. Eligible expenses generally include:

• Medical services like doctor visits, hospital stays, and surgeries
• Dental procedures such as cleanings, fillings, and braces
• Vision care including eye exams, glasses, and contact lenses
• Prescription medications and over-the-counter drugs (with prescription)
• Mental health services

Ineligible expenses typically include:

• Cosmetic procedures
• Health club memberships
• Vitamins and supplements (unless prescribed)

Use-It-or-Lose-It Rule

FSAs are subject to the “Use-It-or-Lose-It” rule, which means that any funds not used by the end of the plan year are forfeited. However, employers may offer one of two options to mitigate this risk:

1. Grace Period: Employers can give employees up to an additional 2.5 months to use the funds after the plan year ends.
2. Carryover: Employers can allow employees to carry over up to $610 (as of 2023) to the next plan year.

Only one of these options can typically be offered, not both.

How to Access Funds

Employees can access their FSA funds in a few different ways:

• Debit Card: Some FSAs come with a debit card that can be used directly at the point of sale for eligible expenses.
• Reimbursement: Employees can pay out-of-pocket for eligible expenses and then submit a claim for reimbursement from the FSA.
• Direct Payment: Some FSAs may allow for direct payment to the service provider.

Employees are required to keep receipts and may need to submit documentation to substantiate claims.

Advantages of FSAs

• Tax Savings: Contributions reduce your taxable income.
• Upfront Funding: The entire annual contribution is available at the beginning of the plan year, which can be advantageous for large expenses early in the year.
• Employer Contributions: Some employers may match employee contributions, though this is less common.

Disadvantages of FSAs

• Forfeiture of Unused Funds: Due to the Use-It-or-Lose-It rule, any unused funds are forfeited at the end of the plan year or grace period.
• Limited Flexibility: Changes to contribution amounts can generally only be made during open enrollment or due to a qualifying life event.

Comparison to Health Savings Accounts (HSAs)

While both FSAs and HSAs offer tax advantages for medical expenses, there are distinct differences:

• Eligibility: HSAs are only available to individuals with high-deductible health plans (HDHPs), while FSAs are not tied to any specific type of health insurance.
• Contribution Limits: HSA contribution limits are generally higher than FSA limits.
• Portability: HSA funds roll over year to year and are owned by the account holder, while FSA funds are subject to forfeiture.
• Investment Growth: HSAs can be invested in mutual funds or other investment vehicles, allowing for tax-free growth, which is not an option with FSAs.

Conclusion

Flexible Spending Accounts offer a tax-advantaged way to cover medical and dependent care expenses. However, understanding the rules and limitations, particularly the Use-It-or-Lose-It rule, is crucial for making the most of an FSA. With careful planning, employees can significantly reduce their taxable income and out-of-pocket healthcare costs, making FSAs a valuable part of an employee benefits package.