What Is a Flexible Spending Account (FSA)?

What Is a Flexible Spending Account (FSA)?

Let me explain what a flexible spending account, or FSA, really is. It's an employer-sponsored savings account where you, as an employee, can set aside pretax funds specifically for qualified medical expenses. This setup helps you save money on taxes, and I've noticed that the list of allowable expenses has expanded lately, making it even more useful.

You contribute a portion of your earnings before taxes, and your employer might chip in too. Any money you take out has to reimburse you for qualified medical and dental services. There's also a dependent-care FSA variant, which covers child-care for kids under 13 or care for qualifying adults like a spouse who can't care for themselves, as long as they meet IRS guidelines. Keep in mind, these have different contribution caps from the medical ones.

Key Takeaways

Here's what you need to know at a glance. An FSA lets you put away part of your earnings pretax to handle health-related costs. Those contributions come straight out of your pay and skip income and payroll taxes. When you pull funds for qualified medical expenses, they're tax-free too. Just remember, you have to use the money by the end of the plan year, though your employer might give you a grace period up to March 15 of the next year.

How a Flexible Spending Account (FSA) Works

One major perk I want to point out is that FSA contributions deduct from your earnings before taxes, which drops your taxable income and can cut your tax bill each year. The IRS sets a cap on contributions—for 2024, it's $3,200 for medical FSAs.

If you're married, your spouse can contribute up to that limit through their own employer. Employers aren't required to add to your FSA, but if they do, it doesn't eat into your personal limit, and you won't pay taxes on their part.

For dependent-care FSAs in 2024, the limit is $5,000 for joint or individual returns, or $2,500 if you're married filing separately.

Pros and Cons of Flexible Spending Accounts (FSAs)

Beyond the tax advantages, FSAs have solid benefits, but they don't cover everything medical or dental. Let me break down the pros and cons directly for you.

Pros

You can use the pretax funds to reimburse medical care payments, which includes costs for diagnosing, curing, mitigating, treating, or preventing diseases affecting the body. FSAs also let you cover qualified medical expenses for your spouse and dependents, not just yourself.

Many medical equipment purchases qualify, like diagnostic devices, bandages, crutches, prescription meds—including OTC drugs with a prescription—and insulin. Plus, you can reimburse deductibles, copayments, and coinsurance from your insurance plan.

Thanks to the CARES Act from 2020, you can now use FSA funds for OTC drugs without a prescription and for menstrual care products, and these changes are permanent.

Cons

Not all procedures or health expenses make the cut—cosmetic surgery or general health items like gym memberships aren't reimbursable. The big downside is the 'use it or lose it' rule: you generally have to spend the money within the plan year, though your employer might offer a 2.5-month grace period or let you carry over up to $610 from 2023 to 2024, or $640 from 2024 to 2025.

FSAs can't pay for insurance premiums, even if they cover deductibles.

Special Considerations

At the end of the year or grace period, any leftover funds in your FSA are gone, so plan your contributions carefully based on what you expect to spend. There's also a limited-purpose FSA (LPFSA), which works alongside a health savings account (HSA)—something standard FSAs can't do. You contribute pretax, but it's only for dental and vision expenses, often paired with a high-deductible health plan where the HSA handles other medical costs.

How Much Should I Contribute to My FSA?

There's no one-size-fits-all amount— it depends on your situation. Look at your anticipated out-of-pocket health costs for the year and contribute up to the max allowed.

What If My Spouse Is Enrolled In a Different Health Insurance Plan?

You can still use your health-care FSA for eligible medical costs for your spouse and tax dependents, no matter their insurance. Just claim them on your tax return, and they can't file their own.

Can I Use an FSA with a Health Insurance Marketplace High-Deductible Plan?

No, you can't pair an FSA with a Marketplace plan. Go for an HSA instead, which lets you save pretax for health expenses with that type of insurance.

The Bottom Line

In summary, an FSA allows you to set aside pretax earnings for medical and dental expenses through your employer, with possible employer contributions. Use it for qualified reimbursements, and there's a dependent-care version too. The IRS caps contributions annually, and you need to spend most of it in the same year to avoid losing funds—so plan accordingly.