What is a Flexible Spending Account (FSA)?

An FSA is like an emergency fund for your health…

Many people have an emergency fund to set aside money for an unexpected setback. After all, what if you lose your job or your car breaks down? An FSA is like an emergency fund, but for a particular purpose. Unlike your regular emergency fund, you don’t have to pay taxes on the money you put into this one. That being said, an FSA also comes with a lot more rules than an emergency fund.

A flexible spending account (FSA) is an employer-sponsored savings account that allows employees to set aside money for qualifying medical and dental expenses.

A flexible spending account (FSA) is run through your employer. If you choose to sign up, you’ll communicate to your employer’s human resources department before the beginning of the year that you’d like to participate and how much you’d like to contribute — up to a maximum of $3,050 in 2023.

Your FSA contributions aren’t subject to federal income taxes. Your employer will withdraw pre-tax dollars from your paycheck for your monthly contribution.

There are a few different ways you might be able to access your FSA funds. You might have a debit card attached to your FSA. Otherwise, you’ll pay medical expenses out of pocket, and then request reimbursement from the FSA. Because an FSA is a defined benefit plan, you’re guaranteed the full amount of your FSA at the beginning of the new year, even if you haven’t made any contributions yet. In other words, you’re allowed to borrow against the money you plan to contribute later in the year.

FSA plans have limited rollover options. Generally, you have to use the funds within the plan year. Your employer determines whether you have the opportunity to roll funds over to a new year. Generally, they’ll offer you one of three options:

• You might be able to roll over $500 from your FSA to the new plan year
• You might have a 2.5 month grace period, meaning you have until mid-March to use the FSA funds from the previous year
• Your employer may choose not to offer any rollover or grace period, which means you lose the money you contributed

A health savings account (HSA) is another type of account, similar to a flexible spending account (FSA), that allows individuals to save for qualified medical expenses. Like with an FSA, both you and your employer can contribute funds into your HSA, and the money is not subject to federal income tax.

Unlike an FSA, which is available to anyone whose employer offers it, an HSA is only available to someone enrolled in a high-deductible health plan (HDHP). Another difference between the two is that individuals with an HDHP can enroll in an HSA through their employer (if they offer it), but they can also enroll in an outside HSA plan. FSA plans, on the other hand, are only available to those whose employers offer them.

As for which is better, it really depends on your situation. For anyone with an HDHP, an HSA might be preferable because the money rolls over indefinitely. If you don’t have an HDHP, then an FSA might be the only option available to you. Depending on your employer and your health insurance plan, it could also be the case that neither option is available for you.

According to the Internal Revenue Service (IRS), qualified medical expenses for purposes of a flexible spending account (FSA) are generally any expenses that you’d be able to deduct on your taxes. Those medical expenses are any related to the diagnosis, cure, mitigation, treatment, or prevention of disease for yourself, your spouse, or your dependents.

The IRS provides the following list of medical expenses (although it clarifies that this list isn’t exhaustive):

• Abortion
• Acupuncture
• Alcoholism (the cost of inpatient treatment for alcohol addiction and transportation to and from Alcoholics Anonymous)
• Ambulance
• Annual physical examination
• Artificial limb
• Artificial teeth
• Bandages
• Birth control pills
• Body scan
• Braille books and magazines
• Breast pumps and supplies
• Breast reconstruction surgery
• Capital expenses (any equipment or home renovations required for individuals with disabilities)
• Car (the installation of special equipment or functions for individuals with disabilities)
• Chiropractor
• Christian Science practitioner
• Contact lenses
• Crutches
• Dental treatment (expenses related to the prevention and alleviation of dental disease)
• Diagnostic devices
• Disabled dependent care expenses
• Drug addiction (the cost of inpatient treatment)
• Drugs (aka medication)
• Eye exam
• Eyeglasses
• Eye surgery
• Fertility enhancement
• Founder’s fee
• Guide dog or service animal
• Health institute
• Health maintenance organization (HMO)
• Hearing aids
• Home care
• Home improvements
• Hospital services
• A special home for intellectually and developmentally disabled
• Laboratory fees
• Lactation expenses
• Lead-based paint removal
• Learning disability
• Legal fees
• Lifetime care
• Lodging (the cost of meals and overnight stay at a hospital or medical institution where you’re staying to receive medical care)
• Long-term care
• Meals (the cost of meals at a hospital or institution where you’re receiving medical care)
• Medical conferences (for chronic illnesses of yourself, your spouse, or your dependent)
• Medical information plan
• Medicines (generally only prescription medications and insulin are qualified medical expenses, not over-the-counter medications)
• Nursing home
• Nursing services
• Operations
• Optometrist
• Organ donors
• Osteopath
• Oxygen
• Physical examination
• Pregnancy test kit
• Prosthesis
• Psychiatric care
• Psychoanalysis
• Psychologist
• Special education
• Sterilization
• Stop-smoking problems
• Surgery
• Telephone (the cost of special telephone equipment for a person who is deaf, hard of hearing, or has a speech disability)
• Television (the cost of equipment to display the audio part of television programs for individuals with hearing disabilities)
• Therapy
• Transplants
• Transportation (the cost of transportation for an essential to medical care)
• Trips (trips required to receive medical care)
• Tuition
• Vasectomy
• Vision correction surgery
• Weight-loss program
• Wheelchair
• Wig
• X-ray

Each year, the Internal Revenue Service sets a limit as to how much an employee can contribute to their flexible spending account (FSA). In 2023 the contribution limit for health FSAs is $3,050. The limit applies to each individual, not each household. If you and your spouse each have access to an FSA through your employer, you may each contribute $3,050.

A health care flexible spending account (FSA) can be an excellent option for people in specific situations. For other people, the FSA might be the wrong option (or not available at all).

Advantages of an FSA:

• The funds you contribute to your FSA are tax-free
• Your employer can make an initial $500 contribution; after that, they can match your contributions dollar for dollar
• You’re guaranteed your full FSA amount on the first day of the plan year (meaning if you plan to contribute $2,500 over the entire year, you can use all $2,500 at any time that year, essentially borrowing against your future contributions)

Disadvantages of an FSA:

• For people with a health plan with a high deductible or high out-of-pocket maximum, the $3,050 contribution limit may not be enough
• Not everyone can participate. You can only participate in an employer-sponsored FSA, and self-employed people cannot participate in an FSA
• An FSA has limited rollover options, and your employer may choose not to allow any rollover or grace period, which means you lose the money you contributed.

When you take a look at the pros and cons of having a flexible spending account (FSA), is it really worth it? The short answer is that it depends. If you expect to spend money on health care throughout the year, then the answer is probably yes.

Thanks to the tax advantages of these accounts, they can save you a lot of money. If you know that you’ll spend $500 this year on medical expenses, going the FSA route allows you to avoid paying taxes on those $500.

FSA plans also provide an extra bit of security since the entire amount you choose to put into your plan is available on the very first day. Suppose you planned to save $1,000 for medical expenses in a year, and then on January 3 were in a car accident that resulted in roughly $1,000 of out-of-pocket costs. If you were using an FSA, you would have access to the entire amount in January. If you were saving it in your bank account instead, you probably wouldn’t have made much of a dent yet.

Because the list of eligible medical expenses is so broad, there’s a good chance you or someone in your family will have costs that qualify.

That being said, if you’re a healthy person and don’t see items on the list of qualified expenses that you expect to pay for, then it might not be worth it for you. There’s a risk of contributing money and not using it, since your employer may not allow you to roll any of that money over — That means you lose it.