Flexible spending accounts (FSA’s) – also known as flexible spending arrangements – allow you to pay for medical bills or childcare expenses on a pre-tax basis.
What is an FSA?
A flexible spending account (FSA) is a pre-tax account deducted from payroll that you can use for qualified medical or childcare expenses. FSA’s are a great way to help pay for medication, visits to the doctor or paying a sitter to watch your kids while you work.
Who’s Eligible?
Flexible spending accounts are only available through your employer, so if the company you work for does not offer it, it won’t be an option for you. You also can’t enroll in an FSA plan if you are self-employed.
Side Note: If your employer doesn’t offer an FSA or you’re self-employed you can sign up for a Medical Savings Account (MSA) or Health Savings Account (HSA).
Three Types of FSA’s
There are three different types of flexible spending accounts, each uniquely suited for your annual needs. Keep in mind however that your employer must offer them in order for you to get access.
1. Health Care FSA
First, and most common, is the Health Care FSA, which helps pay for qualified medical expenses including prescription medications, over-the-counter medicines (with a doctor’s prescription) and medical equipment like crutches, supplies like bandages and diagnostic devices.
Most importantly, you can spend FSA funds to pay deductibles and copayments, but not for insurance premiums.
2. Dependent Care FSA
Dependent Care FSA’s help you pay for child care expenses like sitters and daycare. This is a work benefit so only parents working or looking for work are eligible. So if your spouse stays home with the kids you won’t be able to enroll in a Dependent Care FSA.
And dependents are defined as children under age 13 or adults who can’t mentally or physically care for themselves, so if your kids are older this won’t provide any benefit.
3. Limited Purpose FSA
Third, there is the Limited Purpose FSA, which lets you set aside pre-tax money from your paycheck to pay for out-of-pocket dental and vision costs. Similar to the Health Care FSA, Limited Purpose FSA’s help pay for eye exams, contacts and eyeglasses. Limited purpose FSA’s are designed to work in conjunction with a Health Savings Accounts (HSA’s).
Can You Have Multiple FSA’s?
Yes.
It is perfectly okay to have multiple FSA’s in one household. In fact, if you and your spouse work at different companies and they both offer health care FSA’s you could have two. If this is the case, just make sure you can spend the total limit.
It’s also perfectly okay and common to have a medical FSA and childcare FSA because they cover separate expenses.
But if you have a health care FSA you would not need a limited purpose FSA because health care FSA’s also cover vision and dental expenses.
How Does an FSA Work?
Contribution Limits
The IRS limits how much you, the employee, can contribute to your flexible spending accounts because of the tax benefits. Here are the annual limits by type of FSA:
| Plan Type | Annual Limit – 2022 |
| Health Care FSA | $2,850 per employer |
| Child Care FSA | $5,000 per year per household $2,500 for married individuals filing a separate tax return |
| Limited Purpose FSA | Minimum $120 Maximum $2,750 |
It might be tempting to maximize your account but it’s important to note that FSA/s are “use it or lose it” accounts, which means your employer can keep funds you haven’t used so it’s important to estimate how much you want to contribute each year.
Your employer may also contribute up to $500 per year to your FSA, but the annual limits still apply.
How is Your FSA Funded?
Your FSA is front-loaded by your employer at the beginning of the year.
To offer an example, suppose you opt to max out your Health Care FSA, which is $2,850. You would have access to the entire $2,850 on January 1st. Then throughout the year your employer will deduct from each paycheck in order to fund the FSA throughout the year. So in this example, if you were paid monthly, your FSA deduction would be $237.50 per paycheck ($237.50 x 12 = $2,850).
So flexible spending accounts have the benefit of lowering your taxable income and front-loading your account by your employer. However, keep in mind that if you don’t use all $2,850 then that money will go back to your employer, per IRS rules.
Grace Periods and Carry-Overs
You must use the money in your flexible spending account during the plan year, but your employer may offer one of two options if you don’t exhaust all your funds in 12 months.
- Provide a “grace period” of up to 2 ½ extra months to use the money in your FSA
- Allow you to carry over up to $550 per year to use in the following year
Your employer can offer either one of these options but not both and they are not required to offer either one.
At the end of the year you lose any money left over in your FSA, so it’s important to plan carefully and not put more money in your FSA than you’ll need.
Using Your FSA
Your employer owns the FSA account and can administer in one of two ways.
- A debit or credit card
- Your own money and then submitting receipts for reimbursement
When you have a Health or Limited Purpose FSA, the total amount is available on the first day. For example, if your employer put in $500, and you decided to contribute $500, you would have $1,000 to spend right away.
When you have a dependent care FSA, you can only access your account balance. If your employer put in $500, that’s all you have on day one.
Pros and Cons of FSA’s
Like anything in this world, there are pros and cons to FSA’s. However, if you plan correctly there is very little, if any, downside.
Pros
- Save money on taxes
- Easy to administer and mange
- Great way to budget medical and/or child care expenses for the year
- Funds front-loaded by employer
Cons
- Only available through your employer
- Not available if you’re self-employed
- “Use it or lose it” each year
Summary
Flexible savings account are an easy way to save money on taxes. So if you’re lucky enough to have an employer offer an FSA, and you have a decent idea of how much you’ll spend on medical bills or child care, it’s a no-brainer way to budget and save money. Just make sure to reviews how your company’s specific FSA plans work before enrolling.