A flexible spending account, also known as an FSA, is a type of savings account that you can contribute to tax-free and use to pay for some out of pocket healthcare costs, including copayments, deductibles, and some prescription medications. Employees who receive health insurance coverage through their job are often eligible to contribute to FSAs. We’ll cover what an FSA is, how it works, and the pros and cons of contributing to this type of account.
How a flexible spending account (FSA) works
Employees can contribute up to $2,850 per employer in 2022. In most cases, you have to use the funds in a flexible spending account within one year. These funds can be used to cover the cost of copays, deductibles, prescription medications, and some types of medical equipment, like crutches. You can also use these funds to cover medical expenses for your spouse and dependent children.
Qualifying medical expenses
The IRS provides a list of permitted medical and dental expenses that you can reference when determining whether or not you can use funds in a Flexible Spending Account to cover a certain expense. It’s important to note that you can’t use Flexible Spending accounts to pay for monthly health insurance premiums.
The 2020 CARES Act expanded the types of products that can be paid for using an FSA. Some examples of things that you can use funds in a flexible spending account to pay for include:
- Health insurance copays
- Health insurance deductibles
- Birth control
- Menstrual products
- COVID19-related expenses such as masks and hand sanitizer
- Contact lenses
- First aid kits
Submitting a claim
In order to use the funds in your Flexible Spending Account, you need to submit a claim through your employer along with proof of your medical expense. Then, you’ll receive a reimbursement for the amount of money you spend on a qualified purchase.
Using your funds
If you decide to contribute to a flexible spending account, it’s important to remember that the funds expire after one year. In some cases, your employer may provide a grace period of up to two and a half months, or they may allow you to roll over $550 to the following year.
Because there’s a chance that your funds could expire before you have a chance to use them, you should carefully review your average yearly qualifying medical expenses, and only contribute as much as you think you’ll be likely to spend in a given year.
Do you need an FSA?
Whether or not you need a flexible spending account ultimately depends on a variety of personal factors, including how much you make and how much you and your family spend on qualifying health-related costs each year. Using a flexible spending account can make sense if you have regular medical expenses. Because the money deposited into an FSA is tax-free, you could potentially save hundreds of dollars in income tax each year.
It’s important to keep in mind that you don’t have to deposit the full $2,850 each year in order to use this type of account. You can contribute as much or as little as makes sense for your family up to the $2,850 limit. It’s a good idea to only contribute as much as you think you will spend.
While Flexible Spending Accounts can help you to save on taxes, they may not be the right choice for you depending on your financial situation. First and foremost, only individuals who receive health insurance through their employers are eligible in most cases. In addition, it may make more financial sense to contribute to tax-advantaged accounts like 401(k)s or traditional IRAs before you fund an FSA.
FSA vs. HSA: What’s the difference?
Flexible spending accounts (FSAs) and health savings accounts (HSAs) are both used to fund certain health-related expenses, so it’s easy to confuse the two. However, there are a few important differences between these types of plans.
Flexible spending accounts have less narrow eligibility requirements, and are available to most employees who receive health insurance coverage through their employers. In contrast, health savings accounts are only available to those who purchase certain types of high deductible health insurance plans. Some of the differences between FSAs and HSAs include:
- Eligibility: Individuals with employer-sponsored healthcare are eligible for FSAs, while only individuals with certain high-deductible health insurance plans are eligible for HSAs.
- Contribution limit: FSAs have a contribution limit of $2,850, while HSAs have a contribution limit of $3,650 for individuals and $7,300 for families.
- Rollover rules: FSA funds typically expire at the end of each year, while HSA funds don’t expire.
- Account owners: Employers own FSAs, while individuals own HSAs.
Flexible spending account (FSA) pros and cons
There are both benefits and drawbacks to contributing to a Flexible Spending Account.
- Lowers taxable income: Contributing to a flexible spending account lowers your taxable income, which means that you could save hundreds of dollars in taxes each year depending on your income and contribution amount.
- Can be used for a wide range of qualifying medical expenses: In addition to expenses like copays and deductibles, funds from a flexible spending account can also be used to cover a wide range of health-related expenses, including menstrual products, face masks, hand sanitizer, sunscreen, and more.
- Funds are available right away: Once you pledge to contribute a certain amount to your flexible spending account, the funds are available right away to be used for qualifying medical expenses.
- Funds may expire: Unused funds in your flexible spending account typically expire at the end of the year. While you may be able to take advantage of a short grace period or roll over a limited amount of funds, in general the money stashed in an FSA has an expiration date.
- Owned by your employer: While you can contribute to an FSA, you don’t actually own the account—your employer does. This means that a flexible spending account is tied to your employer, and you may lose your benefits if you switch jobs or are laid off.
- There may be better ways to use your money: Depending on your income, health expenses, and other factors, it may make more sense to max out your contribution to other tax-advantaged accounts, such as a 401(k) with an employer match.
FSAs help lower your tax burden
If you’re able to accurately anticipate a certain number of health-related expenses in a year, it may make sense to contribute to an FSA, especially if you’ve already maxed out your retirement and other tax-advantaged accounts. While there are some drawbacks to FSAs, when used appropriately they can help you to lower your tax burden and save money.