What is an FSA (Flexible Spending Account)?
Savings accounts with tax advantages are called flexible spending accounts (FSAs). An organization can create a “flexible spending arrangement” (FSA) for employees.
You may contribute pretax wages to your FSA, and employers can. Account distributions must compensate employees for eligible medical and dental expenditures.
A dependent-care flexible spending account is a type of FSA that covers childcare expenses for children under 12 and qualifying adults, including spouses, who cannot care for themselves and meet IRS guidelines. Dependent-care FSAs have different maximum contribution limits than medical-related FSAs.
How an FSA Works
One benefit of flexible spending accounts is that contributions are deducted from pretax wages, reducing taxable income. Regular payments to an FSA can lower your annual tax obligation.
The IRS caps FSA contributions annually. The annual contribution maximum for medical expenditure FSA accounts is $3,050 per employee in 2023.
If you’re married, your spouse can contribute up to the yearly maximum through their employment. Employers don’t have to contribute to an FSA, but if they do, it doesn’t lower your contribution. Employer contributions are tax-free.
The 2023 dependent-care FSA contribution maximum is $5,000 for joint and individual tax returns and $2,500 for married taxpayers filing separately.7
The IRS issued recommendations in 2021 to provide businesses with additional flexibility for benefit plans during the COVID-19 pandemic, including health FSAs. These provisions ceased at the start of 2023, save for the remaining money carried over into the first half.
FSA Pros and Cons
FSAs provide tax benefits and some perks for account holders, but they may not cover all medical or dental expenditures. Examples of their benefits and downsides
Pros
- To reimburse medical care expenses, pretax funds contributed to an FSA can be used to diagnose, cure, mitigate, treat, or prevent diseases or conditions affecting any bodily structure.
- FSA owners can utilize the account to pay spouses’ and dependents’ eligible medical expenditures and their own.
- FSAs cover medical equipment purchases such as diagnostic gadgets, bandages, and crutches. FSA money can cover prescription and OTC medicine purchases, including insulin.
- FSAs can reimburse insurance deductibles and medical co-payments.
- The 2020 Coronavirus Aid, Relief, and Economic Security (CARES) Act increased qualifying medical costs to include over-the-counter medications without a prescription. The act also allowed FSA reimbursement for menstruation care goods. Both CARES provisions are permanent.
Cons
- Not covered: some medical procedures or costs. Cosmetic surgery, gym memberships, and other health-related expenses are not reimbursable.
- Funds are “use it or lose it.” Usually, you must spend FSA funds during the plan year. As of January 1, 2023, your employer may provide a “grace period” of up to 2 1/2 months to spend FSA funds or allow you to carry over up to $610 per year for the following year.
- Cannot pay insurance premiums: FSAs can cover insurance deductibles but not coverage.
The IRS informed taxpayers in September 2021 that FSAs, HSAs, and HRAs can cover at-home COVID-19 tests and personal protective equipment like face masks and hand sanitizer. This continued in early 2023.
Special Considerations
Your FSA monies are gone when the year or grace period ends. Thus, you should carefully calculate how much money you will deposit and spend in your account each year.
What Limited Purpose FSAs Do
A “limited purpose flexible spending arrangement” (LPFSA) is a savings plan that can be utilized with a health savings account (HSA), unlike a conventional FSA. Contributions are made from pretax earnings.
Limited-purpose FSAs are more limited, covering only dental, vision, and other charges in high-deductible health plans (HDHPs) if the deductible is reached.
How Much Should I Put in My FSA?
The right amount for each person depends on their position and the FSA election. Evaluate your estimated out-of-pocket healthcare costs for the upcoming year before deciding.
What If My Spouse Has Different Health Insurance?
You can use your healthcare FSA to pay for qualified medical expenses for your spouse and tax dependents, regardless of their insurance. You must claim dependent money on your tax return; dependents cannot submit their return.
Can I use an FSA with a High-Deductible Health Insurance Marketplace Plan?
You cannot utilize an FSA with a Marketplace plan. For a similar product, consider a Health Savings Account (HSA). These allow you to save on health costs if you have this insurance.
Bottom Line
A flexible spending account (FSA) lets you save pretax money for medical and dental costs. Employers create it for workers. Employers can fund employee FSAs. Account distributions must compensate employees for eligible medical and dental expenditures. The dependent care FSA is another option.
Individuals can contribute up to a certain amount every year, and most of the money must be spent in the year it’s saved, so FSA account users must carefully arrange their contributions to prevent losing money.
Conclusion
- The FSA lets employees save a part of their paychecks for health care.
- Contributions are withheld from wages and, hence, not subject to income and payroll taxes.
- FSA withdrawals for eligible medical costs are tax-free.
- Employers can provide a 2-1/2-month grace period until March 15 of the following year to spend FSA funds.
