What Is a Flexible Spending Account?

Important Takeaways

• Flexible spending accounts (FSAs) are employer-sponsored savings programs that help workers pay for some out-of-pocket medical bills or dependent care expenses using tax-free cash.
• You contribute to these accounts by withholding of a percentage from each paycheck during the year.
• Health care FSA funds are available from the beginning of the plan year even if you haven't contributed anything yet, but you must wait until you’ve made contributions to your dependent care accounts before you can utilize them.
• FSAs are excellent for persons who can anticipate annual qualifying expenditures correctly, since if you don't spend all your savings by year-end, you lose it.

 How Flexible Spending Accounts Work

Workers and employers (on behalf of the employee) may contribute to a flexible spending account using pre-tax income when a company provides an FSA. Workers may then spend the cash immediately on qualified costs throughout the covered period, or they can pay out of pocket and seek reimbursement. 

Note
Flexible spending accounts are often called flex accounts, flexible-spending arrangements, or FSAs.

Flexible spending accounts are generally for medical, dental, or dependent care needs. The basic categories of FSAs are health care FSA (HCFSA, health FSA, or medical FSA), special purpose FSAs (for dentistry and vision), and dependent care FSA (DCFSA) (DCFSA). Less prevalent forms of FSAs are adoption assistance FSAs.

Companies aren’t legally obligated to provide FSAs, but if yours does, you may choose whether to join in the plan during the annual benefits enrollment period. You’ll then set aside pre-tax cash from your salary to put toward an FSA to support future eligible costs.

Let's imagine your total income for the year was $70,000 and you made $4,000 in FSA contributions during the year. Just $66,000 of your income would be liable to income tax. Your payments would go into your FSA before Federal Insurance Contribution Act (FICA) (Social Security and Medicare) tax is withdrawn, as well as before Federal Unemployment Tax Act (FUTA) tax, or income taxes are taken out. 

Note
Health FSAs have a contribution ceiling of $2,850 in 2022, and $3,050 in 2023. Dependent care FSAs may have restrictions up to $5,000.

You may use health care FSA money at any time throughout the year, regardless of how much you’ve actually contributed. But only money that's already in a dependent care FSA may go toward qualified costs.

You may participate in both kinds of accounts if your company provides both, but you must make separate elections for and contributions to each.

If you’re already contributing to a health savings account (HSA), your sole FSA choice may be a limited purpose flexible spending account (LPFSA), which only covers vision and dental costs.

How To Utilize FSA Funding

When you join in an FSA, you may obtain a debit card so that you may utilize the money in your accounts to pay approved costs immediately. Alternatively, you may pay out of pocket and request reimbursement subsequently.

You may be tempted to aim for the highest contribution limits to take advantage of the tax advantages, but it’s often a “use it or lose it” scheme. The monies in the account may expire if you don’t spend the money before the end of the year.

Companies may chose to grant a grace period of two and a half months, but they don’t have to. This extends the period you have to spend the money. Health care FSAs offer the added option of enabling you to carry over a maximum of $610 from 2022 to 2023 instead of a grace period. This is also your employer’s choice.

Flexible Spending Accounts: Example

To demonstrate how you might contribute to and utilize money from different types of FSAs let's look at an example. Suppose your firm provides a health care FSA and a dependent care FSA, and permits workers to contribute an annual maximum of $2,750 to the health care FSA and $5,000 to the dependent care FSA. You may opt to put $2,000 into each FSA, and spread your contributions out evenly over the course of a year.

Note
Many FSA plans correlate with the calendar year, but they don’t have to. These may cover any 12-month period, so be sure you understand when your FSA’s plan year starts and finishes.

You have $1,000 saved in each FSA account and you’re halfway towards your financing target six months into the year. You’ve also recently gotten invoices of $1,500 for eligible medical charges and $2,000 for dependent care expenses.

You may instantly seek reimbursement for all $1,500 of medical expenditures, despite only having $1,000 in the account so far since you can utilize HCFSA money at any time throughout the year regardless of how much you’ve contributed.

But you may only utilize the money you really have in a DCFSA toward dependent care expenditures. You would have to wait until you earn additional contributions to obtain reimbursement for the entire $2,000 in dependent care expenditures since you're $500 short at this moment.

Don't forget to seek reimbursement before the end of the plan year since your funds expire unless your company gives a carryover or grace period.

Note
Make a claim to your FSA to obtain a reimbursement. Provide documentation of the eligible cost and a statement explaining why another plan didn’t pay it.

What Do Health Care FSAs Cover?

The IRS defines eligible medical expenditures as the costs of diagnosis, cure, mitigation, and treatment or prevention of illness for any part or function of the body. They include:

• Compensation for services by professional medical practitioners
• Expenses of equipment, supplies, and diagnostic instruments for these reasons
• Transportation expenditures to obtain medical care
• Over-the-counter medication and menstruation care products

Insurance premiums and long-term care expenditures are not reimbursable with a health care FSA, nor are any amounts covered under another health plan.

Qualifying health costs are applicable to you and your spouse, your adult dependents, or your kid under age 27. However dependents who are married and filing joint returns or those who have gross yearly salaries exceeding $4,300 are excluded.

Note
The IRS has issued a statement notifying taxpayers that at-home COVID-19 tests and personal protective equipment, such as face masks and hand sanitizers, are considered eligible medical expenses that can be paid for or reimbursed by health flexible spending arrangements (health FSAs), health savings accounts (HSAs), and health reimbursement arrangements (HRAs) (HRAs).

What Do Dependent Care FSAs Cover?

Qualifying costs for dependent care FSAs often contain services that help you or your spouse work, seek for job, or attend school full time. Some frequent examples are before- and after-school child care, in-home dependent care, and daycare at a facility.

These costs must be for a dependent kid who is under the age of 13 and who you may claim a tax deduction for, or for a spouse or dependent who can’t take care of themselves.

Note
You can’t utilize dependent care FSA money to pay for services that a child’s parent provides. For example, you couldn't use the money deposited to an FSA account to pay your ex-spouse to babysit your kid.

Do I Need a Flexible Spending Account?

Flexible spending accounts tend to help persons who can consistently forecast their medical or dependent care needs throughout the year. Consider utilizing an FSA if you’ve been using daycare for 12 months and feel certain that you’ll spend the same amount in the following 12 months.

If your workplace provides one or more kinds of FSAs, it might be worth reviewing its rules to decide if contributing could benefit you. Examine the options that your company makes for your FSA, such as the contribution limit (your business might pick a lower amount than the IRS permits) or if it gives a grace period for spending the money.

Always note that FSA funds expire. You’ll obtain the biggest advantage if you can spend what you donate within the allowed time limit, but you'll lose money otherwise. Utilizing all your cash decreases your tax bill without diminishing your effective income.

You must deduct any amount you chose to contribute to a dependent care FSA from the Child and Dependent Care federal tax credit. Talk with a tax specialist to discover which plan works best for you.

Commonly Asked Questions (FAQs)

How does a Flexible Spending Account work?

If your workplace provides a health plan, you may contribute to and utilize a Flexible Spending Account (FSA) (FSA). Money you put into this account is tax-free, and you may take it out and use it to offset health care bills like copayments and deductibles. Your employer could opt to contribute to your FSA, but they aren't compelled to.

What can I purchase with my FSA card?

If you have an FSA debit card, you may use it to pay directly for FSA qualified purchases. You may discover a list of things that are often FSA qualified here. If you are unclear about an item, you'll need to talk to your FSA administrator. They may be able to offer you with a list. The money will be taken immediately out of your FSA account.