Flexible Spending Accounts 101 (FSAs)
Flexible Spending Accounts (FSA) are employer-established benefit plans which are generally funded with pre-tax contributions by employers. Employees may also contribute to an FSA. Self employed people are not eligible to participate in an FSA.
Contributions made by an employer can be excluded from your gross income for tax purposes. No employment or federal income taxes are deducted from the contributions. Maximum annual contributions are limited to $2,500.
Self employed people are not eligible to participate in an FSA.
Expenses which can be paid for from a Flexible Spending Account from an IRS perspective are broad. Which expenses are allowed in a particular plan depend on the terms in that plan.
There are two types of Flexible Spending Accounts.
- Health Care FSA: Money in a Health Care FSA is used to reimburse the employee for specified medical expenses as they are incurred. The list of eligible expenses is fairly broad, and includes deductibles and co-pays. To learn more, see: Health Care FSA
- Dependent Care FSA: Money in a Dependent Care FSA is used for the care of eligible dependents while the employee is at work. To learn more, see: Dependent Care FSA
Participation in one type of FSA does not affect participation in another type of FSA. However, funds cannot be transferred from one FSA to another.
An employee can withdraw funds from an FSA to pay qualified expenses even if the employee has not yet placed the funds in the account.
Historically, the main disadvantage of a FSA is the "use it or lose it" rule.- if the money isn't spent within the required period of time, you lose it. However, employers are now allowed to permit workers to carry over FDA balances up to $500 into the next year. In addition:
- Employers have the authority to grant an optional 2.5 month grace period. If there is a grace period, any qualified medical expenses incurred in that period can be paid from any amounts left in the account at the end of the previous year. For example, if the grace period extends to February 28, then February 28 is the deadline for expenses, not December 31.
- The rules relate to when the expense is incurred, not when the purchased items are used. For instance, if the grace period extends to February 28, expenses incurred February 21 but not paid for until March can be paid from the FSA as if they were paid for in the previous year.)
The most common method of avoiding the "use it or lose it" rule is to use any money left in the account at year end to stock-up on what you normally use for yourself and your family.
If you are terminated from work, funds in FSA account are subject to COBRA.
For additional information, see:
- Health Care FSAs
- Dependent Care FSAs
NOTE: You can have both a FSA and a Health Savings Account (HSA). If you have both accounts, you can only pay for a qualified expense once. You cannot double dip the benefits.