What Is a Flexible Spending Account?

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Even when you have health insurance coverage, you’ll likely still need to pay a variety of out-of-pocket costs associated with your medical visits, your medications and maintaining your general wellbeing. One way employers can help make these costs more affordable for employees is by offering a special type of health and wellness savings account called a flexible spending account (FSA).

You can put the money that’s in an FSA towards a variety of health-related costs, which helps you save money on out-of-pocket payments. In addition, FSAs have tax benefits that can help you save even more money each year. But to make the most out of an FSA — or to decide whether you want to opt into one — it’s important to understand the basics. Learn more about what FSAs are, how they work, and what some of their pros and cons are to get started.

Flexible Spending Account Basics

FSAs are savings accounts available through employers. You can use the money that’s deposited into yours to pay for eligible expenses — they’re typically healthcare related but can depend on the type of FSA you have. If your employer offers an FSA as a benefit, both you and your employer can deposit money into the account. Employers aren’t required to make contributions to employee FSAs, however, and can choose whether or not to make them. Your contributions are made via deductions from your paycheck. You get to decide how much of your income to contribute to your FSA each pay period and can schedule regular contributions or make lump-sum payments. When you spend the money in the account, you must use it to cover qualifying expenses. 

FSAs are only available through employers that choose to offer them. If you’re self-employed, you can only get an FSA if you set up an FSA plan for both yourself and other employees you have. FSAs are also tax-favored accounts. They don’t earn any interest like a traditional bank account does, but the money in the account also isn’t taxed. When you make a voluntary contribution to your FSA, your annual taxable income shrinks by the amount of your contribution, and you pay less in taxes on the paycheck the contribution came out of. Due to the accounts’ tax-favored status, the IRS makes important decisions about what expenses qualify for FSA coverage. 

Types of Flexible Spending Accounts

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Typically, when you hear people talk about FSAs, they’re referring to medical FSAs. While these aren’t the only type, they’re one of the most common. These healthcare FSAs are strictly for medical costs, which include things like paying the full cost of medical appointments before you meet your deductible, paying for appointment copays after you meet your deductible or paying for some wellness products your insurance doesn’t cover. 

Dependent care FSAs hold funds you use to cover the costs of some types of care your dependents receive during the day while you’re at work. You can contribute up to $5,000 per year to this type of FSA.

A dependent care FSA covers costs for services like child and adult daycare and summer day camps. The accounts cannot cover expenses for a dependent’s medical care, clothing, feeding or private school tuition. Daycare for your toddler during your workday qualifies, but hiring a nanny to care for your child while you go on a weekend getaway wouldn’t be an eligible expense. The funds are intended to help you access services that make it easier for you to maintain your work schedule during the day.

Although they’re less common, adoption FSAs are another type of account. The funds in an adoption assistance FSA can help you pay for eligible costs related to adopting a child, such as legal or agency fees.

How Do Flexible Spending Accounts Work?

Although medical costs can be expensive, FSAs still have limits on what your account can hold and, subsequently, the amount of money you can spend each year using FSA funds. The annual limit is per employer, not per person, so you could have access to more FSA funds if you have more than one job. In that case, you could max out the annual limit for each job you work. For 2022, the annual contribution limit per employer is $2,850 per individual.

You have to use your FSA funds within the calendar year for which they’re deposited. If you don’t use all of your FSA money within a year, however, you have options. You can continue to use the funds from one year for a grace period of up to two and a half months into the following year. You can also roll over up to $550 in unspent funds from one year into the account for the following year. If you don’t spend the money in the right year or during the grace period, you lose the money you saved.

How to Use Flexible Spending Accounts

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FSAs don’t work exactly like bank accounts with debit cards. Instead, they’re more like insurance claims. Often, you’ll pay for the cost of an eligible item or service out of pocket first and then your FSA will reimburse you.

There are forms you can use to apply for FSA reimbursement that are somewhat like simplified versions of health insurance claim forms. You provide details about the expense and include proof of payment. Then, the FSA reimburses you for all or a portion of the cost. Just as you’d get a pre-authorization from a health insurance company before having a surgical procedure done, it’s wise to seek confirmation that an expense you’re considering qualifies for reimbursement under the terms of your FSA before paying for it. 

Everyday products like shaving cream, tampons, skincare products and pain-relief creams may qualify as over-the-counter expenses under your FSA. There are even online stores that exclusively sell products that are eligible for FSA spending. Some employers issue cards for a portion of your total FSA amount. You can use this kind of card to make in-store purchases for certain over-the-counter health and wellness-related costs. 

What Are Some Pros and Cons of Flexible Spending Accounts?

Depositing money in an FSA comes with tax advantages. Although the money comes out of your paycheck, anything you deposit into your FSA doesn’t count towards your total annual income at tax time. If you contribute $2,400 to your FSA during the year, that equates to $2,400 that you don’t have to declare as income at tax time. Suppose that $2,400 total was divided into $200 contributions from each of your monthly paychecks. On each check, you’d also see a tax advantage. The $200 deduction would reduce your taxed amount by $200, resulting in fewer taxes paid on every paycheck. 

The primary disadvantage of using an FSA is the possibility of losing your money if you contribute more to the account than you can spend in a year. Deciding how much money to contribute to your FSA isn’t something you want to guess at. Instead, it’s important to carefully consider your likely medical needs for the upcoming year. Factor in the cost of your deductible and any out-of-pocket costs you know about in advance. FSA contribution calculators available online can help you decide how much to contribute based on your family size and usual healthcare costs.