What Is a Flexible Spending Account (FSA)?

Written by Meagan DrewUpdated: 21st Jul 2022
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Anyone who has a health plan through their employer is eligible to enroll in a Flexible Spending Account or FSA if their employer has one.

The FSA is tax-free savings account that employees can use to pay qualified medical expenses like medical equipment, prescriptions, co-pays, and deductibles.

FSA Fast Facts

  • Employer owned and provided account
  • Provides tax-advantaged payments for qualified expenses
  • FSAs are “used it or lose it.”
  • Funds not used may be kept by the employer

What Is a Flexible Spending Account (FSA)?

A flexible spending account (which is sometimes called a flexible spending arrangement) is a savings account owned and provided by an employer that allows employees to pay qualified expenses with pre-tax dollars.

How Flexible Spending Accounts (FSA) Work

In a Flexible Spending Account or FSA, employees can contribute a portion of their paychecks to the account to later pay qualified expenses.

FSA dollars are then deducted from overall income at tax time, similar to Traditional IRA Contributions, and so they are considered tax-free.

Because the government is allowing money to be put away tax-free essentially, there are lots of regulations regarding how FSAs can be used, and they have strict contribution limits of $2750 per employee.

Employers can also make contributions to the account, but that does not reduce the amount that each employee can contribute- that stays at a maximum of $2750 per year.

Any distributions from the FSA account must be used to pay qualified medical expenses.

Employees typically have a year-long period to use the money in their FSA, but any money not used at the end of the year can be handled one of two ways, and it’s at the employer’s discretion.

Employers can allow an additional 2.5-month grace period, or they can allow $500 to be carried into the next year, but not both. Funds still in the account after these provisions are forfeited to the employer.

FSA Pros & Cons

Pros:

  • Provides tax-free payment or reimbursement for qualified medical expenses
  • FSA funds may also be used to pay some insurance plan deductibles and medical co-payments
  • FSA funds pay for medical equipment purchases
  • Menstrual care products and over-the-counter medicines are covered

Cons:

  • Funds not used by the end of the year/end of the grace period are lost
  • Cannot use FSA funds to pay for elective procedures or vitamins

What Are the Benefits of Having a Flexible Spending Account?

The greatest benefit with a Flexible Spending Account or FSA is the ability to reduce taxable income while paying for expenses you’d probably have anyway.

Because FSA contributions are tax-free, it’s like you’re saving at least 10% (depending on your tax bracket) every time you use your account.

The CARES Act of 2020 further expanded the list of reimbursable medical expenses, and now menstrual care products, bandages, and over-the-counter medicines are just some of the new additions to the qualified medical expense list, making it even more likely that all of the FSA dollars can be spent by the end of the year.

The major downfall of an FSA is that whatever is not used will be lost, and much of that risk is mitigated with the expansion of expenses that qualify.

Is It Worth Having a Flexible Spending Account?

Flexible Spending Accounts offer a lot of benefits for those who accurately predict how much money they will need in any given year for qualified medical expenses.

The reduction to taxable income is a major perk, but not if the employee uses none of the FSA funds and has to forfeit them at the end of the year.

FSA Alternatives

Health Savings Account

The major difference between a Flexible Spending Account or FSA and a Health Savings Account or HSA lies in the ownership.

In an HSA, the employee is the owner of the account. In an FSA, the employer is the owner of the account.

HSAs have higher contribution limits than FSAs, and because their ownership is not tied to their employment, funds can be rolled over from year to year.

>>More: FSA vs. HSA

Bottom Line: What Is a Flexible Spending Account (FSA)?

A Flexible Spending Account or FSA is a savings account provided by employers to allow employees to pay for qualified expenses with tax-free money.

They’re great for anyone who can reasonably estimate how much money they would need for medical expenses without leaving any money on the table.

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Meagan Drew
Meagan Drew

Meagan Drew is a Senior Personal Finance Writer & Product Analyst with 7 years experience in wealth management. As a former Series 7 and 63 certified advisor, Meagan specializes in making financial topics relatable and consumable, no matter the reader’s experience level. She attended the United States Military Academy at West Point where she studied Nuclear Engineering. Meagan is a veteran, military spouse, and mom of 4 currently living in Colorado Springs. Her areas of expertise are military personal finance, credit cards, personal loans, investing, and wealth management.