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What Is a Flexible Spending Account?

Updated
Maurie Backman
By: Maurie Backman

Our Personal Finance Expert

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If you work for a company, you're generally allowed to sign up for workplace benefits in the fall during open enrollment. One benefit you may have access to is a flexible spending account (FSA). But what is a flexible spending account? Let’s explore.

What is a flexible spending account?

A flexible spending account is a tax-advantaged savings account that allows you to set aside money for healthcare and dependent care. Each year, there's a maximum limit you can contribute to an FSA.

FSA contributions go in on a pre-tax basis, which means the IRS doesn't tax you on that money. If you put $1,000 into an FSA, you don't pay taxes on that $1,000 portion of your salary.

Healthcare FSAs

A healthcare FSA is a medical expense account you can use to pay for different expenses throughout the year. Some eligible healthcare expenses include:

  • Copays for doctor visits
  • Copays for prescription medications
  • Certain over-the-counter medications
  • Prescription eyeglasses, sunglasses, and contact lenses
  • Dental care
  • Braces and orthodonture

For a complete list of eligible healthcare expenses, you can access this FSA eligibility list.

When you sign up for an FSA, you allocate a certain amount of money toward healthcare expenses up to the annual limit. For 2022, the limit is $2,750.

Some FSAs issue participants a debit card that can be used to pay for medical expenses up front. Those expenses are charged against your FSA balance. Other flexible spending account providers require you to pay for your healthcare expenses out of pocket and submit claims for reimbursement. You can generally sign up to be reimbursed via direct deposit. Your setup will depend on the plan your employer offers.

Dependent care FSAs

If you pay for childcare to either work or look for work, you're eligible to contribute to a dependent care FSA. You can use the money in your account to pay for things like:

  • Daycare centers
  • Preschool
  • After-school care
  • Summer camp

Similar to a health FSA, you may need to pay for your dependent care expenses up front and get reimbursed through your plan. For 2022, dependent care FSAs max out at $5,000 per family (not per child).

If you have an FSA through your employer and your spouse has one as well, you can each put in $2,750 for medical expenses. But you can only put in a total of $5,000 between the two of you for childcare expenses.

Benefits of FSAs

The primary benefit of saving in an FSA is that you get to lower your tax bill. If you normally fall into the 22% tax bracket based on your income, and you put $5,000 into an FSA, you'll save $1,100 on taxes.

Also, with an FSA, you're effectively forced to set money aside for healthcare and dependent care expenses. When you sign up with your employer, you'll allocate the amount you want to contribute, and that money will be deducted from your paychecks during the year. Then, when you incur an eligible expense, you can pay for it with your FSA instead of having to dip into your savings account.

If a medical emergency arises, having money available in an FSA could prevent you from going into debt or having to raid your emergency fund, which you may need for other purposes.

Drawbacks of FSAs

No matter which type of flexible spending account you have, your FSA will work on a use-it-or-lose-it basis. What this means is the money you put into your FSA must be used up in the course of your plan year. Any funds you have left over could potentially be forfeited.

Now, there are some exceptions to that rule. If you reach the end of your plan year and still have unused funds in your FSA, you may, depending on your company, have one of two options:

  • A grace period that allows you to still rack up eligible expenses for a few months into your next plan year
  • A rollover amount that you can move from one plan year to another

But not every employer offers these options, so you'll need to check the specifics of your plan to see what they entail. Either way, when you sign up for an FSA, you risk having to forfeit funds if your healthcare or childcare expenses for the year end up being lower than expected.

Another drawback of FSAs is that if you leave your job, you'll need to use up your funds by your last day of employment or generally risk losing them. Unlike 401(k)s, which allow you to roll your money into a new retirement plan, FSA funds cannot be rolled over.

FSAs versus HSAs

An FSA may not be the only health savings plan you can sign up for through your employer. You may also have access to a health savings account (HSA).

HSAs are similar to FSAs since they allow you to contribute pre-tax dollars toward healthcare expenses, and there's an annual contribution limit that changes from year to year. But these plans also differ in a few big ways.

First, FSA funds cannot be invested while they're sitting in your account unused. However, HSA funds can be invested so they grow into a larger sum over time, and as an added benefit, those investment gains aren't subject to taxes.

HSA funds also never expire. You can put money into an HSA throughout your career and carry that money with you into retirement.

Another key difference is that not everyone can participate in an HSA. To qualify, you must be enrolled in a high-deductible health insurance plan. The definition of that changes every year, and generally, when your employer presents you with your options for health insurance, you'll be told which plans are HSA-eligible. With an FSA, it doesn't matter what health insurance plan you have.

You should also know that you can't have an FSA and an HSA at the same time. However, if you have a health savings account, you may be eligible for a limited-purpose FSA, which allows you to use an FSA for specific expenses like dental and vision care.

Should you sign up for an FSA?

Having a flexible spending account could make it easier to pay for health and dependent care expenses as they arise. Saving in one of these accounts could also lower your tax bill, making it a wise personal finance move.

That said, if you're having a hard time deciding how much money to put into your FSA, you may want to err on the side of contributing less, not more. Forfeiting FSA funds essentially means throwing money away, and that's something you don't want to do.

FAQs

  • Anyone whose employer offers a flexible spending account can sign up. You can only claim childcare expenses on a dependent care FSA if you need that care to work or look for work.

  • Healthcare FSAs cover medical expenses like copays, eyeglasses, and dental care. Dependent care FSAs cover childcare costs like daycare, preschool, summer camp, and after-school care programs.

  • An FSA can lower your taxes substantially. The money you contribute to an FSA goes in on a pre-tax basis, which means the IRS won't tax you on that portion of your earnings.

  • Once you leave your employer, you lose your FSA. If you're planning to switch jobs, it's important to try to use up your FSA balance before making that change.

  • If you spend a lot on healthcare and childcare, then an FSA offers you a chance to save money by lowering your tax bill. But if you don't have dependents and tend to spend little on medical care, then you may not need an FSA, or the benefit to you might be minimal.

Our Personal Finance Expert