Flexible Spending Account (FSA)

Many firms offer flexible spending accounts as a perk to employees. These accounts are unique pre-tax spending accounts. You can use these accounts to pay for necessary expenses without having to pay taxes on the money you deposit there. Find out what an FSA may pay for and how utilizing one to pay for regular expenses can help you pay less in taxes.

What is Flexible Spending Account ?

A flexible spending account (also referred to as FSAs or flexible spending arrangements) is a type of savings account that provides the account holder with specific tax advantages. FSA can be set up through your employer. The account allows you to contribute a portion of regular earnings, employers also can contribute to employees’ accounts.

The United States, Internal Revenue Service (IRS) allows flexible spending account funds to be used for eligible medical expenses incurred by an account owner and their spouse. Additionally, subject to certain qualifications, the IRS permits the use of FSA money by any individual listed as a dependent on the tax return of the FSA owner.

A worker can contribute pretax earnings to a flexible spending account to cover eligible medical costs. Co-pays, prescription drugs, chiropractic appointments, eyeglasses, and LASIK eye surgery might all fall under this category.

Kay Facts of Flexible Spending Account

  • An employer-sponsored savings account known as a flexible spending account (FSA) enables employees to use tax-free money to cover a portion of their out-of-pocket medical or dependent care expenses.
  • Contributions to the account are taken out of wages and are not taxed at the income or payroll levels.
  • Amounts taken out of an FSA to cover eligible medical costs are tax-free.
  • Employers may grant a grace period of up to two and a half months, or until March 15 of the following year, for employees to use their FSA funds before the end of the plan year.
  • Contributions to an flexible spending account have an annual limit, which is adjusted for changes in the cost of living by the Internal Revenue Service every year.
  • FSA funds may be used to pay for eligible medical expenses incurred by the FSA owner or the owner's spouse.

How Does the Flexible Spending Accounts Work ?

Tax-advantaged accounts known as flexible spending accounts are only available to people through their employment. They offer a great opportunity to use pretax money to save money for medical costs or child or dependent care.

You can use FSAs to set aside a percentage of your normal income to cover eligible medical and dental expenses. FSA beneficiaries who use the funds for eligible medical costs and use up the full amount of their contribution in a given year are free from paying federal income tax and employment tax on both contributions to and dividends from FSAs. By the conclusion of the plan year, the funds in an FSA must be expended. There may be a grace period for using the leftover funds in an FSA account, though, depending on the employer.

When an employer offers an FSA, both employees and employers may make pre-tax contributions to the account. Then, throughout the covered time, employees can either pay out-of-pocket and seek reimbursement, or they can spend the money directly on qualified expenses.

Who is Eligible for Flexible Spending Account ?

Flexible spending account are primarily for salaried employees, since only qualified employers can administer and establish FSA plans. Self-employed individuals are not eligible to open FSAs.

As long as their employer provides health insurance, the majority of full-time employees are qualified to use an FSA. Employees can participate in an FSA without first signing up for a health insurance plan.

An employee who works 30 or more hours per week is qualified to join the company's FSA on the first of the month after their employment date.

  • After the plan is set up, current employees may enroll during their company's initial enrollment period (during FSA Open Enrollment, or due to a qualifying life event).
  • Newly hired employees have 30 days after being hired to enroll in an flexible spending account.
  • If there are any union employees, they will be able to take part in the FSA.

Employees Ineligible for FSA

Some employees are not eligible to enroll in an flexible spending account. Which are :
  • Self-employed workers and shareholders who own 2% or more of an S-Corp, LLC, LLP, PC, sole proprietorship, or partnerships are often ineligible for FSAs, however there are certain exceptions.
  • Employees with HSAs should not enroll in flexible spending account. However, employees with health savings account are only able to enroll in a Dependent Care FSA.
  • The tax benefits of the plan are not available to business owners.

What is the FSA Contribution Limit ?

The FSA contribution limit is set by the IRS and is annually indexed to inflation. Maximum contribution limit to a flexible spending account is $2,850 in 2022, and $3,050 in 2023. Dependent care FSAs can have limits up to $5,000.

The IRS released the 2023 FSA contribution limit in October 2022. The cap increased by $200 from the previous year. Compared to other years, this is a comparatively significant increase. Employees will be able to make FSA contributions up to $3,050 in 2023. Your spouse can contribute up to the maximum amount if they have a separate FSA under a different employer's plan.

How Much of FSA Can Roll Over ?

For 2023, the carryover option allows you to roll over up to $610 of unused flexible spending account money at the end of the plan year. It increased from $570 in 2022.

FSA Grace Period

Some FSA include a grace period at the end of the year. This is a predetermined period of time during which you may spend any remaining funds in your FSA. The grace period can be up to a maximum of 2.5 months after the start of new year, which would be March 15th of the year after your contribution. The grace period may be less than 2.5 months depending on how your plan is set up. Any unutilized FSA balance would be forfeited following the grace period.

Run-Out Period

Run-out is a time frame set aside for submitting claims for the preceding year. If your run-out period extends to March 31, for example, you have until then to submit claims for expenses you spent prior to that date. You should consult your plan administrator or the HR department to learn about critical dates and information regarding your plan because run-out periods might differ from plan to plan.

However, since FSA contributions do not necessarily carry over to the next year, you will benefit tax-wise the most if you only make contributions to your FSA that you are certain you will be able to use by the end of the year. You will receive the most tax benefit if you utilize the entire balance in your FSA each year.

Flexible Spending Accounts Eligible Expenses

The annual contribution limit applies to flexible spending account. FSA allows you to pay for qualified out-of-pocket expenses, like : 
  • Medical expenses (like monthly period supplies and over-the-counter products)
  • Copayments
  • Prescription medications 
  • Dental and orthodontic expenses
  • Eye exams
  • Medical equipment (such as crutches, hearing aids, contact lenses, eyeglasses, or blood sugar testing kits)
  • Childcare expenses (such as daycare payment)

Qualified medical expenses are those that would be eligible for medical and dental expense deductions and are listed in an FSA plan's description, according to IRS Publication 502.

Facelifts, liposuction, hair removal, and teeth whitening are examples of medical expenses for procedures that do not qualify for FSA payouts. Owners of FSAs must pay taxes on any unreimbursed medical expenses.

Money in flexible spending account may not be used to pay for insurance premiums.

Types of Flexible Spending Account

FSA are usually for dental, medical or dependent care expenses. The types of flexible spending accounts are dependent care FSA (DCFSA), limited purpose FSA and health care FSA (health FSA, HCFSA or medical FSA).

1) Health Care FSA :
For medical, vision, and dental costs not covered by another health plan, medical FSAs can be used. Medical FSAs are especially beneficial because of the rising expense of prescription drugs and medical treatment. If another health, vision, or dental plan does not provide coverage for some medical expenses, you can use the money in them to pay for consultations, medications, and other medical expenses. Additionally, you can utilize a medical FSA to pay for over-the-counter medical costs or alternative treatments, like :
  • Over-the-counter medication
  • Menstrual care products
  • Birth control
  • Denture cleaner
  • Alcoholism treatment
  • Acupuncture
  • Lasik
  • Fertility treatments
  • Orthodontia

Only when medical expenses total more than 7.5% of your adjusted gross income are they tax deductible, and only if you itemize all of your deductions as opposed to taking the standard deduction. First, medical FSAs lower your taxable income. Then, funds contributed to a medical FSA can be used to pay for costs, many of which are not otherwise tax-deductible.

2) Limited Purpose FSA :
You can only contribute to Limited Purpose FSAs while also making an HSA contribution. This is due to the fact that these FSAs may only be used to cover out-of-pocket costs for vision and dental care. Using your Limited Purpose FSA for dental and vision costs enables you to set aside more money in your HSA for retirement, so it's a smart idea to use both if your employer provides them. You can use the IRS-set annual contribution cap for Limited Purpose FSAs to pay for yourself, your spouse, and your dependents.

3) Dependent Care FSA :
Another type of FSA is a dependent-care FSA, which is used to pay for childcare expenses for children age 12 and under and can also be used to pay for the care of qualifying adults, including a spouse, who cannot care for themselves and meet specific IRS guidelines. A dependent-care flexible spending account has different maximum contribution rules than a medical-related flexible spending account. Dependent care flexible spending accounts are used to set aside pre-tax dollars to pay for qualified dependent care expenses. This can include :
  • Daycare or preschool
  • Day camp
  • Adult daycare for elderly or disabled adults
  • A nanny or babysitter
  • After school care
  • Custodial elder care

You typically cannot claim the Dependent Care Tax Credit on your income taxes, if you use your FSA to pay for dependent care. To determine which sort of savings will benefit you more, speak with a tax expert.

How to Enroll in Flexible Spending Account ?

During the open enrollment period prior to the start of each plan year, eligible employees may enroll online or by filling out and submitting an enrollment form.

An FSA must be provided by an employer in order to be enrolled in. You will receive enrollment guide from your company or the benefits administrator. As part of this enrollment, you will need to elect the amount of funds you want to set aside for the plan year.

You might be given a form to complete for enrollment or your employer might ask you to complete your FSA elections on an employee benefits system. Your employer may ask you to fill out your flexible spending account elections in the employee benefits system, or you may be provided with a form to fill out the enrollment.

When Can Enroll in FSA ? 

You can enroll or make changes in flexible spending account during :
  • Annual open enrollment period.
  • New-employee eligibility period.
  • After certain changes in employment status or qualifying life events (such as change in marital status or arrival of a new child).

Frequently Asked Questions

How does a FSA work?
You can fund and use a Flexible Spending Account if your workplace provides a health plan. You can withdraw money from this account tax-free and use it to pay for medical expenses, such as copayments and deductibles. Your employer isn't obligated to make a contribution to your FSA, but they may do so if they so desire.

What can I buy with FSA card?
You can pay directly for FSA-eligible items if you have an FSA debit card. Here is a list of items that are typically covered by the FSA. You must consult your FSA administrator if you have any questions about a particular item. You might be able to get a list from them. Your FSA account will be instantly debited for the amount.

What if my spouse has a different health insurance plan?
Regardless of the medical insurance they are registered in, you can use money from your healthcare FSA to cover qualified medical costs for your spouse and tax dependents. Dependents cannot submit their own tax returns and must be claimed on your tax return in order to receive cash for them.

Does an FSA reduce my taxable income?
Yes, an FSA lowers your taxable income since pre-tax funds are used to pay your contributions. However, since they were paid with pre-tax funds, FSA expenses cannot be written off.

How much can you save on taxes with an flexible spending account?
You can save up to 30% when using your FSA to pay for eligible costs by using pre-tax money. However, if your account permits rollovers, you must make sure to use all of the funds in it each year, or at the very least, up to the rollover limit. If not, you forfeit the money and would be spending it rather than conserving it.

Can I change annual contribution amount to my FSA?
In most cases, employers allow their employees to adjust their contributions during the plan year. However, this may depend on the plan design.

Can I use a flexible spending account to reimburse myself?
You can pay for medical expenses out of the money in your flexible spending account, but you'll need to keep track of your receipts and payments to make sure they qualify as medical expenses. If not, you risk being liable for fines and taxes.

Can I enroll in FSA at any time?
Prior to the start of the plan year, you can enroll in the plan during your employer's open enrollment period. If you are a newly hired employee or if you experience a qualified Status Change Event as described in the Summary Plan Description, you may also enroll in the middle of the year.

How do I use My FSA funds?
You might be given a debit card when you sign up for an FSA, allowing you to utilize the money in your accounts to cover approved charges immediately, or you could pay the costs yourself and then apply for reimbursement. To profit from the tax advantages, you might be tempted to make the maximum contributions allowed, but this is often a "use it or lose it" system. If you don't spend the money by the end of the year, the cash in the account could expire. Employers have the option, but not the obligation, to provide a two and a half month grace period. As a result, you have more time to use the money.

Who may use FSA funds?
FSA money may be used to pay for eligible medical expenditures incurred by the FSA owner as well as by the owner's spouse. In a dependent care FSA, a spouse may also utilize funds to cover child care costs for dependents. Dependents who are listed on the owner's tax return may also use FSA distributions.

What are the benefits of flexible spending account?
  • Other vision-related costs, such those for glasses, contacts, eye exams, and trips to the optometrist, can be covered by your FSA.
  • You can save money on expenditures you would have paid for anyhow because FSA monies are deducted from your paycheck prior to taxes. Your taxable income at the end of the year is also decreased.
  • Only employer-sponsored health care plans are eligible for FSAs, so employers may also make contributions.

What are the disadvantages of flexible spending account?
  • By the end of the calendar year, FSA funds must be spent or they will be returned to your employer. Employers may allow employees to use any unused FSA funds up to 2.5 months after the end of the plan year as a grace period.
  • Some employers might not provide their workers' FSAs a grace period. That's because they have complete discretion over whether to provide one and, if so, how long it will last.

What is the differences between FSA and HSA ?
You cannot open an FSA if you are self-employed or unemployed because they are only available through employers. HSAs, on the other hand, can be opened by anyone because they are individual accounts. These accounts can be opened at a financial institution that qualifies.
Your employer may contribute money to either or both accounts. You cannot, however, take your FSA with you if you leave your employment. Fortunately, your HSA is a portable account, so you can still access your savings even if you lose your job.