What Is a Flexible Spending Account (FSA)?
A flexible spending account (FSA) is a unique savings account that offers special tax benefits. Sometimes referred to as a “flexible spending arrangement,” an FSA is established by an employer for employees and allows for pre-tax contributions from your earnings. Employers may also contribute to employees’ FSAs.
This account is designed to reimburse the employee for qualified expenses related to medical and dental services. A different type of FSA exists for dependent-care expenses, covering costs associated with childcare and the care of qualifying adults. The contribution limits for dependent-care FSAs differ from those of medical-related FSAs.
Key Takeaways
- FSAs allow you to contribute a portion of your regular earnings before tax to cover health-related costs.
- Contributions aren’t subject to income and payroll taxes.
- Withdrawals to pay for qualified medical expenses aren’t taxed.
- Most FSA funds must be used by the end of the plan year, with a grace period option up to March 15 of the following year.
How a Flexible Spending Account (FSA) Works
One significant advantage of an FSA is that contributions are deducted from earnings before taxes, thus reducing taxable income and annual tax liability.
The IRS caps FSA contributions annually, with a limit of $3,200 for medical expense FSAs in 2024. If married, your spouse can also contribute up to the annual limit through their employer, and employer contributions don’t reduce your permissible contribution amount. Employer contributions are not taxable.
For dependent-care FSAs, the 2024 limit is $5,000 for joint and individual tax returns, and $2,500 for married taxpayers filing separately. Recent IRS guidance allowed temporary flexibility for unused funds due to COVID-19, but many provisions have ended, except some carrying over until early in the subsequent year.
Pros and Cons of Flexible Spending Accounts (FSAs)
FSAs offer substantial tax benefits and advantages, but they also have limitations. Here are the pros and cons:
Pros
- Tax Savings: Contributions made with pre-tax funds mean substantial tax savings.
- Broad Usage: FSAs cover a wide range of medical and dental expenses, including some over-the-counter and menstrual care products, thanks to the CARES Act.
- Dependents’ Expenses: You can use FSA funds for your spouse’s and dependents’ qualified medical expenses.
- Medical Equipment: Diagnostic tools, supplies like bandages and crutches, and prescription medications are covered.
- Insurance Deductibles: FSAs can be used to reimburse amounts paid for insurance plan deductibles, copayments, and coinsurance.
Cons
- Limited Eligibility: Expenses related to cosmetic surgery or gym memberships are not reimbursable.
- Use It or Lose It: Generally, any funds in an FSA must be used within the plan year unless your employer opts for a grace period or carryover option.
- Insurance Premiums: FSAs cannot be utilized to pay for insurance premiums.
During the COVID-19 pandemic, the IRS specified that at-home tests and personal protective equipment like masks and sanitizer could be reimbursed by FSAs.
Special Considerations
Any remaining FSA funds at the end of the year—or grace period—are forfeited, which necessitates a careful estimation of contributions based on expected annual expenses.
How Limited Purpose FSAs Work
A “limited purpose flexible spending arrangement” (LPFSA) contributes using pre-tax earnings but primarily covers dental and vision costs—suitable for use alongside a Health Savings Account (HSA) and a high-deductible health plan (HDHP).
How Much Should I Contribute to My FSA?
Contribution amounts should reflect your anticipated out-of-pocket healthcare expenses for the upcoming year. It’s vital to evaluate your specific situation when making your election.
What If My Spouse is Enrolled In a Different Health Insurance Plan?
You can use FSA funds for eligible medical expenses for your spouse and tax dependents, irrespective of their health insurance plans. Dependents must be enlisted on your tax return and cannot file independently.
Can I Use an FSA with a Health Insurance Marketplace High-Deductible Plan?
FSAs are not usable with Marketplace plans. However, a similar product called a Health Savings Account (HSA) is available. HSAs allow pre-tax contributions to cover healthcare costs under such health insurance plans.
The Bottom Line
A flexible spending account (FSA) allows you to set apart pre-tax earnings for medical and dental expenses, strengthening your savings. Set up by your employer, FSAs can gain additional contributions from them too. It’s important to estimate your annual contributions wisely to avoid losing unspent funds due to their “use it or lose it” nature.
Related Terms: Health Savings Account, pretax earnings, dependent-care FSA.
References
- Internal Revenue Service. “Publication 969 (2022), Health Savings Accounts and Other Tax-Favored Health Plans”.
- Internal Revenue Service. “Publication 503 (2022), Child and Dependent Care Expenses”.
- Internal Revenue Service. “Publication 969”. Page 3.
- Internal Revenue Service. “IRS: 2024 Flexible Spending Arrangement Contribution Limit Rises by $150”.
- National Institutes of Health. “Flexible Spending Accounts Program – New 2024 Limits For The HCFSA And LEX HCFSA”.
- Internal Revenue Service. “Additional Relief for Coronavirus Disease (COVID-19) Under § 125 Cafeteria Plans”.
- Healthcare.gov. “Using a Flexible Spending Account (FSA)”.
- Internal Revenue Service. “Publication 502 (2022), Medical and Dental Expenses”.
- Internal Revenue Service. “IRS Outlines Changes to Health Care Spending Available Under CARES Act”.
- Internal Revenue Service. “IRS: 2024 Flexible Spending Arrangement Contribution Limit Rises by $150”.
- Healthcare.gov. “Using a Flexible Spending Account (FSA)”.
- Internal Revenue Service. “IRS: Cost of Home Testing for COVID-19 Is Eligible Medical Expense; Reimbursable Under FSAs, HSAs”.
- U.S. Office of Personnel Management. “Flexible Spending Account”.
- Internal Revenue Service. “Publication 969”. Page 9.
- HealthCare.gov. “Using a Flexible Spending Account”.
