What is a Flexible Spending Account (FSA) & How Can You Use It?

livewell
November 9, 2024
Noah Bennett

Introduction

Many people rely on government-sponsored or private insurance schemes and other health-saving tools to manage their healthcare costs. One of these tools that assists in saving money on healthcare costs is FSA (flexible spending account). These accounts can contribute to lowering healthcare expenses for eligible candidates. However, there are certain types and features of FSA that influence the medical assistance of members. Therefore, knowing details about Flexible Spending Account is necessary to fully use its benefits and use it wisely according to your requirements and limitations. In this blog, we will try to answer all FSA-related questions.

What is FSA?

A Flexible Saving Account (FSA) is an employer-sponsored special savings account for the employees of an organization. This account lets the employees keep their pre-tax money and use it to pay for their medical expenses. The main advantage of these accounts is related to Tax exemptions. The money you pay to these accounts is not included in your paycheck. It thus lowers your annual taxable income. It means the money you contribute to these emergency medical funds remains tax-free.

Many employers offer FSAs as part of compensation and other packages to employees. These healthcare benefits are not available freely and have several limitations and regulations. However, they can prove to be an effective policy for reducing medical expenses if used with proper planning and consideration. Unlike many other healthcare programs, FSAs are not limited to specific medical conditions and can be used for a wide range of medical problems. This enables the users to manage these healthcare funds with flexibility and ease.

Main Features of FSAs

The following are the primary features that help you understand the functioning of FSAs and their impacts on users.

Pre-Tax Contributions

The money you pay for your FSAs is not included in your paycheck and therefore you can avoid paying taxes on this contribution. This can reduce taxes on your overall income and cut your overall tax bill.

Use-it-or-lose-it

In general, the policy followed by many FSAs is use-it-or-lose-it. It means you cannot carry any funds to the next year if they are allocated for a year and not used by the end of the year or the plan year. However, sometimes employers may give a grace period to utilize these funds or allow them to carry a small amount of unused funds to the following year.

Employer Contribution

Employers have no obligation to contribute to the FSA, but some may provide this advantage to their employees. This contribution can be in the form of a one-time allowance or other contributions suitable to the plan.

Limited Duration

The duration for FSAs is generally only a single year. It means you need to reapply next year for FSA during an open enrollment period of your employer for the continuity of this service.

Types of FSAs

Most people are only aware of the Healthcare FSA, but there are other variations of this account. All these accounts have varying features and fulfill the requirements of employees with different requirements.

Healthcare FSA (HCFSA)

It is also known as Standard FSA and covers many general medical expenses related to employees. These include costs of prescription medications, doctor visits, and others.

Dependent Care FSA

This FSA covers medical expenses related to dependents of employees, such as disabled adults and children under 13 years. It includes caring for these dependents and enables employees to work efficiently without worrying about their loved ones.

Limited Purpose FSA

This FSA only covers expenses for vision and dental issues. It is usually preferred by people with a Health Savings Account (HSA) because HSAs cover most medical expenses, other than dental and vision expenses.

FSA vs. HSA

Flexible Spending Account (FSA) and Health Savings Account (HSA) have many similarities but they are different and have varying eligibility requirements. Both are suitable for people with different necessities. Both FSAs and HSAs provide health-saving facilities for employees, and they are tax-free. However, there are also several differences between these accounts.

FSAs have lower contribution limits and their funds usually expire if not utilized within a year. HSAs, on the other hand, have higher contribution limits and users can carry their unused funds to accomplish medical expenses for the next year. Unlike FSAs, HSAs are owned by employees and they can continue these accounts even after leaving their company. Additionally, eligibility requirements for both accounts are also different.

FSA Working Process

he first step of an FSA for employers is to enroll in their employer’s Flexible Spending Account program during the open enrollment period. This process usually takes place once a year. In the second step, the employee will decide about his contribution to the program, which can be up to the Flexible spending Account limits. This amount may vary according to the contribution allowed by the employer.

After enrollment, the employee becomes eligible to use his allocated funds throughout the year. These contributions are deducted from your paychecks and the employers receive a checkbook or debit card linked to their FSA, depending on the administration plan of their employer.

FSA Eligibility Requirements

FSA makes it easier for eligible candidates to fulfill their major medical expenses from their payroll without paying taxes on these accounts. However, one can only get this account after fulfilling its requirements. These include:

The first and the primary requirement for a Flexible Spending Account is its availability to employees. People doing their own business are not eligible for FSAs.
Dependents of the employees may also be eligible for these accounts. Eligible dependents include children younger than 13 years and older adults with disabilities.
The employee must work for a company that offers FSAs for the benefit of their employees.
People with HSA are also eligible for a limited-purpose Flexible Spending Account (LPFSA). It covers only vision and dental medical costs.

FSA Eligible Expenses

FSA is available to pay several medical expenses. These include but are not limited to:

Prescription medications
Chiropractic care
Mental health services
Physical therapy
Doctor visits (deductibles, copays, and coinsurance)
Dental care (cleanings, fillings, and braces)
Vision care (glasses, contact lenses, and eye exams)
Certain medical supplies (thermometers, bandages, etc.)

Tax Benefits of FSAs

The most visible advantage of a Flexible Spending Account is tax savings. Contributions to FSA are made from payroll and are not included in the taxable amount. This provides considerable savings as it reduces your overall Medicare taxes, federal taxes, and social security.

For instance, if your annual income is $70,000 and you pay $5,000 in FSA, your taxable income becomes $65,000. This can provide significant differences to those with higher incomes as it changes their tax bracket.

FSA becomes more beneficial for employees according to their residence. In some places, Flexible Spending Account can reduce state and local government taxes as well, increasing their tax advantage.

How to Use an FSA

You require complete planning to use your FSA effectively. The following methods can assist you in taking full advantage of your program and avoiding its shortcomings.

Carefully Estimating Medical Expenses

The main rule for FSAs is use-it-or-lose-lit. Therefore, estimating your possible medical expenses is of utmost importance. Committing mistakes in this estimation can either cause you to lose money by contributing too much than your medical requirements or may result in contributing too little which may result in an increase of your out-of-pocket expenses for necessary or possible medical costs.

You can do so by reviewing your medical expenses of the recent past and doing some early medical examinations to understand your current health conditions.

Spend Wisely

It is necessary to avoid unnecessary medical expenses in the first and second quarters of the year to preserve funds for the remaining periods. If additional funds are available in the last quarter, you can spend them on already planned procedures, such as eye exams, dental procedures, and even unprescribed medications.

Grace Periods of Carryover Options

Some employers are more lenient than others and may allow grace periods or carry a limited amount to the next year. If you have any of these options, then consider using them effectively. In the case of the prior option, you can delay your unnecessary medical spending during the grace period. For the second option, you should save the amount eligible to be carried out the next year and spend the remaining expenses freely.

Conclusion

A Flexible Savings Account (FSA) is a great tool for employees as they use it to spend on their medical expenses and reduce federal and state taxes on their annual salary. However, proper planning is necessary to utilize these funds effectively due to their use-it-or-lose-it rule. Strategically using these funds can assist you in reducing medical expenses without being affected by the above rule.

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What is the use-it-or-lose-it rule in FSA?

This rule is applied to all the users of FSA. Under this rule, the employee will lose his funds if he can’t utilize them in the same year. These funds can’t be carried to the next year.

What is the difference between FSA and HSA?

There are several differences between these two accounts. The main difference is that the remaining funds in FSA can’t be carried to the next year, while there is no such restriction for HSA. Eligibility requirements for both accounts are also different.

Who is eligible for an FSA?

Only full-time employees are eligible for a Flexible Spending Account. The FSA is available for them if their employer offers health insurance.