What is a Flexible Spending Account (FSA)?
A flexible spending account (FSA) is an employer‑sponsored account that lets you set aside pre‑tax wages to pay for qualified health‑care or dependent‑care expenses. Contributions reduce your taxable income, distributions reimburse you for eligible expenses, and employers may also contribute. There are two common types:
– Health‑care (medical) FSA — pays eligible medical, dental, vision, and other health expenses.
– Dependent‑care FSA — pays eligible child‑care or qualifying adult‑care expenses (different rules/limits).
Key takeaways
– FSA contributions are taken from pay before tax, lowering your taxable income and reducing tax liability.
– IRS limits apply: for 2024 the health‑care FSA limit is $3,200; the dependent‑care FSA limit is $5,000 (single or joint) or $2,500 (married filing separately). Employers may also contribute.
– Most FSAs have a “use it or lose it” rule: unused funds at year‑end (or after any employer‑offered grace period) are forfeited.
– A limited‑purpose FSA (LPFSA) can be used with an HSA and typically covers only dental and vision.
– The CARES Act permanently expanded eligible items to include over‑the‑counter medicines (no prescription) and menstrual care products.
How an FSA works — overview
– You elect a contribution amount during your employer’s open enrollment (or when eligible).
– Your employer reduces your wages each pay period by that amount on a pre‑tax basis and deposits the funds into your FSA. Employers can also add funds.
– When you incur an eligible expense, you submit a claim (receipt or proof) to your FSA administrator and are reimbursed from the account. Many FSAs provide a debit card for eligible purchases.
– Reimbursements must be for IRS‑approved qualified expenses; otherwise the distribution is taxable and may be subject to penalties.
Important rules and limits (highlights)
– 2024 health‑care FSA individual contribution limit: $3,200.
– 2024 dependent‑care FSA limit: $5,000 (single or married filing jointly) or $2,500 (married filing separately).
– Employer contributions are not taxed to you and do not reduce your personal contribution limit.
– Funds generally must be used in the plan year (or during any plan‑specific grace period); unused funds may be forfeited.
– FSA funds cannot be used to pay insurance premiums.
– You can use health‑care FSA funds to pay eligible expenses for your spouse and dependents if they are your tax dependents or are claimed on your tax return (see IRS rules).
Sources: IRS Publications 969 & 502; IRS 2024 FSA limit notice; Healthcare.gov; Investopedia.
Pros and cons of FSAs
Pros
– Tax savings: contributions are pre‑tax, lowering taxable income.
– Immediate access to full health‑care FSA election amount (many plans allow you to use the full annual election at the start of the year).
– Covers a broadening list of eligible expenses (including OTC meds and menstrual products).
– Can pay for out‑of‑pocket costs like co‑pays, deductibles, dental/vision services, and some medical devices.
Cons
– Use‑it‑or‑lose‑it risk: unspent funds may be forfeited at year‑end or after any grace period.
– Not all medical expenses qualify; premiums are generally ineligible.
– Coordination with spouse’s plan and tax rules can be complex.
– If you leave your job, unused funds may be forfeited (unless your plan allows claims for expenses incurred while employed).
Special considerations and rules
– Grace period or carryover: Some employers offer a short grace period or allow a small carryover amount into the next plan year; check your plan’s rules carefully. (If offered, the plan documents specify the length/carryover amount.)
– Dependent‑care FSA: different eligibility and substantiation requirements; reimbursements must be for care that enables you (and your spouse, if applicable) to work or look for work. The tax treatment and limits differ from health‑care FSAs. (See IRS Pub 503 for details.)
– LPFSA + HSA compatibility: A limited‑purpose FSA restricts reimbursements to dental/vision and can be used alongside an HSA (standard FSAs generally make you ineligible for an HSA).
– CARES Act: permanently allows reimbursement of over‑the‑counter medicines without a prescription and menstrual care products.
How limited‑purpose FSAs work
– A limited‑purpose FSA (LPFSA) is an employer‑offered option intended for employees who also contribute to a health savings account (HSA).
– LPFSAs typically cover only dental and vision expenses; some plans allow preventive care.
– Because the LPFSA does not reimburse general medical expenses, you remain eligible to contribute to an HSA.
How much should I contribute to my FSA?
No single right answer—estimate based on anticipated out‑of‑pocket health and dependent‑care costs for the coming year. Practical approach:
1. Review last year’s medical, dental, vision and prescription costs (co‑pays, deductibles, prescriptions, planned procedures, glasses/contacts, dental work).
2. Add predictable recurring purchases (e.g., monthly meds, contact solution, planned orthodontia payments).
3. For dependent care, estimate annual child‑care costs or adult‑care expenses that qualify.
4. Subtract expected reimbursements from insurance and any health savings account (HSA) coverage for the same items.
5. Choose an election conservatively—don’t overfund given the potential forfeiture risk. If your employer offers a grace period or carryover, factor that in.
6. If unsure, consider a lower amount you are confident you will use, then increase in future years as you get a feel for actual usage.
Practical steps: how to enroll and use an FSA
1. During open enrollment (or upon becoming eligible), read your employer’s FSA plan documents and choose the type(s) to enroll in. Confirm plan year dates, claim deadlines, grace/carryover rules, and whether a debit card is offered.
2. Estimate a realistic election amount using the guidance above. Enter that amount on the enrollment form.
3. After enrollment, keep receipts and Explanation of Benefits (EOBs) for all eligible expenses. Check the IRS eligible expenses list (Publication 502) and your plan’s eligible expense list.
4. Pay for eligible items using your FSA debit card (if provided) or pay out of pocket and submit claims with receipts for reimbursement. Submit claims promptly and before plan deadlines.
5. Track your balance regularly via the FSA administrator’s website or app to avoid year‑end surprises.
6. Before plan year end (or grace period end), use remaining funds for eligible purchases (e.g., stock up on eligible OTC meds, schedule dental/vision care).
What if my spouse is enrolled in a different health insurance plan?
– You can use your health‑care FSA to pay for eligible medical expenses for your spouse and tax dependents regardless of which health plan they are enrolled in, provided they are your dependents as defined for tax purposes (or are claimed on your tax return). Confirm dependent eligibility and keep documentation. (See IRS guidelines.)
Can I use an FSA with a Health Insurance Marketplace plan?
– FSAs are employer‑sponsored and generally are not available through the Health Insurance Marketplace in the same way. If you have a Marketplace plan and are eligible for an HSA (i.e., enrolled in a qualifying high‑deductible health plan), an HSA is the tax‑advantaged vehicle intended for that scenario. Consult your employer/Marketplace resources to determine plan compatibility.
The bottom line — practical summary
An FSA is a valuable tax‑saving tool for predictable medical and dependent‑care costs if your employer offers one. Because contributions are pre‑tax, you lower taxable income and can save on taxes for eligible expenses. However, FSAs require planning to avoid forfeiting unused funds and to ensure you don’t over‑contribute. Review your employer’s specific plan rules, IRS guidance on eligible expenses, and 2024 contribution limits before deciding.
Primary sources and further reading
– Investopedia: What Is a Flexible Spending Account (Michela Buttignol).
– Internal Revenue Service, Publication 969 (Health Savings Accounts and Other Tax‑Favored Health Plans).
– Internal Revenue Service, Publication 502 (Medical and Dental Expenses).
– Internal Revenue Service, Publication 503 (Child and Dependent Care Expenses).
– IRS announcement: 2024 Flexible Spending Arrangement Contribution Limit Rises by $150.
– Healthcare.gov: Using a Flexible Spending Account (FSA).
– U.S. Office of Personnel Management: Flexible Spending Account.
If you’d like, I can:
– Help you estimate a contribution based on your prior 12 months of expenses (you can paste numbers).
– Create a one‑year checklist to use FSA funds efficiently (purchase timing, receipts to save, claim deadlines).