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What is a flexible spending account?

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A flexible spending account (FSA) is a type of savings account that can be used to cover health-care or dependent-care costs. It’s an employer-sponsored account, and in this regard differs from a health savings account (HSA). An FSA can also help consumers save money on taxes, since the money in the account is nontaxable.

What is a flexible spending account?

An FSA is a savings account that is employer sponsored, nontaxable and used to pay for health-care or dependent-care costs. It earns no interest.

When you contribute to an FSA, the money is taken from your paycheck before taxes are taken out and is never taxed. The Federal FSA Program estimates that those with an FSA save 30 percent on health-care expenses on average.

It’s also possible to spend more than what’s currently available in the FSA to cover expenses, as long as the set contributions add up to those expenses by the end of the year.

Employers may also make contributions to an employee’s FSA, up to the annual contribution limit, though they aren’t required to.

How does an FSA work?

Employees can enroll in an FSA if it’s offered by their employer. They set a contribution amount to be deducted from each paycheck, up to the federal limit.

The funds in an FSA can be used to cover eligible expenses throughout the year, but they generally don’t rollover after the year is up. Some employers may provide a grace period or may allow a small amount of funds to carry into the next year. Otherwise, any funds leftover are lost.

When you have an eligible expense, you submit a claim to the FSA plan administrator with proof of the expense and a statement that the expense is not covered by your health-care plan. Then, the expense is reimbursed with funds from the FSA balance. Most plans also include a debit card, which can be used to make purchases directly from the account and eliminate the need to seek reimbursement.

IRS rules don’t permit you to use FSA money to pay for insurance premiums. Only out-of-pocket expenses are eligible.

Two types of FSAs are available — a health care FSA (HCFSA) and a dependent care FSA (DCFSA) —  and the expenses covered depend on the type of account you have.

Health-care FSA

An HCFSA generally pays for medical, dental and vision care expenses that aren’t covered by a health-care plan.

With an HCFSA, employees may either submit a request for reimbursement by check or direct deposit, or they can use an employer-provided debit or credit card that is reimbursed without the need to submit a claim.

Expenses covered by an HCFSA include most medical expenses, but cosmetic procedures and insurance premiums are ineligible. Some examples of eligible health-care expenses are:

  • Prescribed over-the-counter medicine
  • Insulin with or without prescription
  • Dental and vision exams
  • Dental cleanings
  • Contact lenses and supplies
  • Physical therapy
  • Surgery
  • Bandages
  • Pregnancy test kits

A complete list of eligible expenses is available on the IRS website.

Dependent-care FSA

A DCFSA can be used to pay for expenses related to caring for a child or an adult dependent. The FSA may require receipts for all eligible expenses to reimburse them.

Some examples of eligible dependent care expenses are:

  • Before and after school care
  • Babysitting expenses
  • Preschool
  • Summer day camp
  • Adult day care

How much can I contribute to an FSA?

The maximum amount that you can contribute to an HCFSA each year is $2,850. If you have a spouse, they may also contribute up to $2,850 a year in a separate FSA.

For DCFSAs, the maximum amount a year is $5,000, for individuals or for couples.

Employer contributions count toward these limits.

Any amount left in the FSA at the end of the year is generally forfeited, unless the employer allows for one of two transfer options. The first option allows for an employer to provide a grace period of up to 2½ months during which the employee can still use any remaining FSA money. The other option is for up to $570 of the employee’s FSA balance to carry over into the next year.

Pros and cons of FSAs

Pros

  • Contributions aren’t subject to taxes: Money deducted from your paycheck for an FSA isn’t taxed, which also reduces the total of your taxable income and therefore helps to save on taxes.
  • You can spend more than the FSA’s balance: FSAs reimburse employees for all eligible expenses, as long as the contributions are sufficient to cover the expenses by the end of the year.
  • Employers may match contributions: Employers can contribute to an FSA, as long as the total combined contributions don’t exceed $2,850 for a health FSA or $5,000 for a DCFSA.
  • FSA money can pay for expenses not covered by insurance: You can use an FSA to cover co-pays, for example.

Cons

  • You can only use FSA funds for a limited time: Leftover contributions made to an FSA are generally forfeited at the end of the year.
  • The account doesn’t earn interest: Funds can’t be invested in an FSA, unlike an health-savings account (HSA), which does earn interest.
  • FSAs are owned by the employer: If you leave an employer who sponsors your FSA, the funds in the FSA are forfeited.

How does an FSA differ from a health savings account (HSA)?

Though both types of accounts are nontaxable savings accounts that can be used to cover health-care expenses, FSAs differ from HSAs in several key ways, most notably in who owns them. An FSA is owned by the employer, while an HSA is owned by the employee. For this reason, an employee has more control over the account. They may change the contribution amount at any time, and they keep the account regardless of whether they move jobs or retire.

The funds in an HSA don’t expire at the end of the year, so any unused balance is carried over into the next year. HSAs also earn interest, unlike FSAs, so funds can be invested in an HSA.

On the other hand, you can only spend from an HSA what’s available in its current balance. An FSA functions somewhat like credit in that you can pay for eligible expenses even if the funds aren’t available in your account yet. An HSA functions more like a checking account.

If I have an HSA, can I have an FSA, too?

Usually, employees can’t have both an HSA and FSA at the same time. There is an exception, which is when an HSA is paired with a limited-purpose FSA.

A limited FSA covers dental and vision care only. It can be used in conjunction with an HSA in case the amount of eligible expenses exceeds what’s available in the HSA balance.

For example, a worker who knows she’ll be getting extensive dental work done throughout the year may want to open a limited FSA, since it can be used to cover dental expenses even if the cost is more than what’s in her account. Then, all of the dental care costs are paid through her HSA and limited FSA, and she can subtract those amounts from her taxable income and save more.

Bottom line

Opening an FSA is a great way to save money on taxes and prepare for health-care costs. As with other types of savings accounts, it allows you to contribute and stash away money, but in this case, that money is taken out of your paychecks in a set amount and is nontaxable. Check to see if your employer matches contributions as well.

Since FSAs don’t allow unused money to carry over at the end of the year, it’s important to avoid overestimating how much you should deduct from your income for contributions to the account. If you’d prefer an account with a balance that doesn’t expire, consider opening an HSA instead, if your employer offers one.

Written by
René Bennett
Banking writer
René Bennett is a writer for Bankrate, reporting on banking products and personal finance.
Edited by
Wealth editor