What Is an FSA and How Does It Work?
If you have the option of getting a flexible spending account through your employer, you should know exactly what it involves and how you can take advantage of this benefit. Incorporating an FSA into your healthcare plan can mean big savings for you and your dependents.
Learn all about this employer-sponsored benefit so you can decide if it will work for you.
What Is a Flexible Spending Account?
A flexible spending account, also referred to as a flexible spending arrangement, is a dedicated account for certain out-of-pocket healthcare expenses. Employers can offer FSAs with any type of health insurance plan, but they’re not required to contribute to the accounts. Instead, employees fund their accounts themselves, using pretax income. FSAs are not available for Marketplace (Obamacare) health insurance plans.
How Do Flexible Spending Accounts Work?
You’ll typically opt in to your employer’s flexible spending account during your annual benefits enrollment period. At that time, you indicate how much you want to contribute, and how often. The money is automatically withheld from your paycheck before taxes are taken out.
Whenever you incur a qualified medical expense, you can get reimbursement for the cost by submitting a claim to your employer along with receipts documenting the purchases or medical services you received. Your employer will withdraw money from your flexible spending account to reimburse you for the costs.
Types of Flexing Savings Accounts
There are several types of FSAs, and your employer might offer some or all of them. They include:
- Health FSA: Reimburses all qualified medical expenses
- Limited-Purpose FSA: Reimburses dental and vision care only
- Dependent-Care FSA: Reimburses expenses related to child day care and adult day care for the participating employee’s children under age 13 and disabled relatives they claim as dependents
FSA funds can be used for you, your spouse and eligible dependents for a variety of medical and health-related expenses, and the list has been expanded slightly for 2021. Qualified expenses include:
- Physician, chiropractic and acupuncture fees not paid by your insurance
- Prescription medications
- Over-the-counter medicine
- Medical equipment like crutches, bandages and blood sugar test kits
- Menstrual care and feminine hygiene products
- Dental and vision expenses, such as co-pays, dental night guards, contacts and eyeglasses
FSA Rules and Limitations
A few important rules exist around having an FSA. Understand them so you can better decide if and how to use such an account for yourself.
First, your FSA is a tax-advantaged account, so the IRS imposes limits on how much you can contribute. The current limit for a health FSA is $2,750 per year per employer. Your spouse can also contribute $2,750 into their own FSA each year. The benefit is that you don’t pay tax on the money you contribute or on the reimbursements you receive for any qualified medical expenses you claim.
The FSA program employs a “use it or lose it” approach — if you don’t use the funds in your FSA, you’ll lose them at the end of the plan year. However, your employer might have an option that lets you keep the funds longer. It can offer a grace period of up to two and a half months, during which you can use the money in your account. Alternatively, it can allow you to carry up to $550 over to the following year.
These options are strictly voluntary on your employer’s part, and it can only offer one, so it’s important to find out the terms of your policy so you can plan your medical flexible spending account funds accordingly.
Good To Know
The IRS has acknowledged that because of COVID-19, employees who participate in an FSA are more likely than usual to have unused funds in their accounts. It is allowing employers to offer a 12-month grace period from the plan’s year-end to allow employees to carry over unused 2021 funds into 2022. Also, in the event that you stopped participating in your employer’s FSA plan in 2020 or 2021, your employer can continue reimbursing you from any unused balance that remains in your account through the end of the plan year.
Use the Tax Advantage of an FSA
The main benefit of an FSA is that your account is funded with pretax money, so all the money you put into this account and use is not subject to taxes. Depending on how much money you put in your FSA, that can add up to a significant amount — especially if you use the program multiple years. Maximize the tax break by contributing as much as you’ll spend, up to the $2,750 limit.
Difference Between an FSA and an HSA
- FSA funds can’t be used to pay insurance premiums, but you can use money from your HSA for COBRA and other health plan premiums within IRS guidelines.
- Whereas your employer can offer an FSA with any type of health plan, you must have a high-deductible health plan to be eligible for an HSA.
- Unlike with an FSA, which only allows contributions from you and your employer, family members and others can contribute to your HSA.
- HSAs allow higher contributions. You can contribute up to $3,550 to an HSA if your high-deductible health plan covers only you; you can contribute up to $7,100 if you have family coverage.
- HSA balances don’t have to be spent. You can withdraw unused funds once you reach age 65 without penalty, although you will pay income tax on the distribution.
Is an FSA Right for Me?
The simple answer to whether flexible spending accounts are worth considering is yes, especially if you will spend money on a co-pay or deductible, get a procedure like LASIK or buy prescription drugs within one year of opening your account. Because each person’s healthcare needs are different, it’s up to you to determine your needs and anticipated medical expenses. Unused funds can be lost, so it makes sense to carefully estimate how much money you’ll spend on eligible healthcare in the following 12 months before you enroll in an FSA.
Natalie Campisi contributed to the reporting for this article.
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