Flexible spending accounts (FSA) allow you to pay medical bills with tax-advantaged dollars. If your medical insurance plan offers an FSA, you may consider contributing to it each year. Here is a closer look at the flexible spending account, how it works, along with some FSA advantages and disadvantages.
Table of Contents
- What Is a Flexible Spending Account (FSA)?
- Who Qualifies for an FSA?
- Maximum FSA Limit
- How Do FSAs Work?
- FSA-Eligible Expenses
- FSA Spending Deadline
- Flexible Spending Account Pros and Cons
- FSA Alternatives
- Flexible Spending Account: Final Thoughts
What Is a Flexible Spending Account (FSA)?
A flexible spending account is a tax-advantaged savings program for medical expenses. Some providers may also call this a flexible spending arrangement. Your contributions are pre-tax dollars that reduce your taxable income. However, there are annual contribution limits, and your unused funds may expire at the end of the calendar year. While this account is an excellent way to save money on medical bills, it’s an employer-provided benefit. So, unfortunately, you can’t open this account from a standalone marketplace like other savings accounts.
Health Care FSA
A Health Care FSA is the most common flexible spending account option. Use this account for out-of-pocket medical, dental, and vision expenses that you or a family member incur throughout the year.
Limited Expense Health Care FSA
While the Health Care FSA is the most common FSA type, your employer may offer a limited expense health care FSA instead if they also offer a health savings account (HSA) to save for medical expenses instead. This account is for dental and vision-related expenses but not medical treatment.
Dependent Care FSA
Your workplace may also offer a dependent care FSA to cover childcare expenses with pre-tax dollars. Usually, your employer will offer the health care FSA and the dependent care FSA. It’s important to note that you can’t use these funds to pay for doctor visits and similar expenses. This account is for select child and adult care-related expenses such as:
- Before or after-school programs
- Summer day camp (overnight camps are ineligible)
Your child may need to be under 13 years old to be eligible for these services. Bills related to care for your spouse, relative, or an adult child incapable of being alone while you work are also eligible.
Who Qualifies for an FSA?
You must work for an employer offering an FSA to be eligible. If this account is one of your employee benefits, you can choose how much you contribute from each paycheck. Your spouse can also have an FSA if their employer offers it. If so, your household has two FSA accounts and can make double the annual contributions. You will need to enroll in this account during your workplace insurance open enrollment season. Then, your savings account opens on January 1st (for most people) when your new insurance coverage plan goes into effect.
Maximum FSA Limit
Your annual contribution limit is different for each FSA account type:
- Medical FSA: $2,850 (up to $5,700 for couples)
- Dependent Care FSA: $5,000 (up to $10,000 for couples)
The minimum annual contribution is $100 for either account type. For 2021 only, the dependent care FSA contribution limit was $10,500 because of the American Rescue Act. As a reminder, your spouse must also have an FSA-eligible health plan and can contribute to their account.
How Do FSAs Work?
Here is an overview of how you can open an FSA, use your funds, and prevent them from expiring.
Enroll In an FSA
You can enroll in your FSA options during your employer’s open season (usually October and November). They can be for a medical account, dependent care, or both. If you get hired mid-year, you may be able to open an account for the remaining months and will re-enroll each open season.
Choose Your Contribution Amount
You must contribute at least $100 per year but can contribute up to the limit. In 2022, that’s $2,850 for health care FSAs and $5,000 for dependent care FSAs. The FSA annual contribution limit is similar to IRA and 401k retirement plans. Whether you have a solo or family health plan, your contribution limit is the same.
FSA Tax Benefits
Your entire contribution is an “above the line” tax deduction that reduces your taxable income. This account is an easy way to get tax benefits for the inevitable doctor bills. However, before you contribute the maximum amount, it’s vital to know that your unused balance will expire, and the carryover rules are strict. So, you may decide to play it safe and only make a partial contribution to avoid losing money.
Pay for Qualifying Expenses
There can be three different ways to pay your FSA-eligible expenses:
- Debit card: You will receive a debit card that can pay for in-office expenses and out-of-pocket costs after receiving your Explanation of Benefits (EOB). Your FSA provider may still require you to send the billing statement to validate the purchase.
- Self-reimbursement: You can pay the bill with your personal funds and seek reimbursement later. Consider this option if you have insufficient FSA funds to foot the bill or you want to earn credit card rewards.
- Directly pay the provider: Your medical or dependent care provider may accept payments from your FSA provider after sending an invoice.
Be sure to keep a receipt of your transactions for tax purposes. As you’re paying for these expenses with pre-tax dollars, your FSA-reimbursed medical expenses are not tax-deductible if you can file an itemized tax return for your remaining out-of-pocket doctor bills.
Ideally, you will use your entire FSA balance before December 31st, so you don’t have to worry about expiring funds. But, if you end up having fewer medical expenses than you anticipate, you not only get to avoid a trip to the doctor but can roll some of your funds into next year. Your provider may let you carry over up to $570 or renew your balance for up to 2 ½ months.
The carryover method depends on your employer’s plan, and your first FSA-eligible expenses in the new year will use last year’s balance. Also, any rollover balance doesn’t reduce your maximum contribution amount for the upcoming year. So, in addition to your carryover amount, you can contribute up to $2,850 into a Medical FSA.
Your health care FSA can pay for many medical, dental, and vision expenses. Here are some ways to spend FSA dollars for each health category.
A trip to the doctor and corresponding treatments and prescriptions are qualifying expenses. Some of the eligible services include:
- Ambulance service
- Artificial limbs
- Body scan
- Copays and coinsurance payments
- Hearing aids
- Lab fees
- Overnight hospital stays and meals
- Prescription-only medication
- Surgery (excludes cosmetic surgery)
- Physical exams (annual physical and diagnostic exams)
- Therapy (as a necessary medical treatment)
- Weight loss programs (to treat a physician-diagnosed disease)
Qualifying dental expenses can include:
- Copays and coinsurance
Cosmetic treatments are ineligible.
Here are some of the qualifying vision care expenses:
- Eye exams
- Eye drops and treatments (over-the-counter)
- Optometrist or ophthalmologist fees
- Prescription eyeglasses and contact lenses
Learn more: You can find a full list of eligible expenses from this government website.
FSA Spending Deadline
Unlike some health savings plans, your funds have an expiration date. You should strive to spend your entire FSA balance before December 31st as you may not be able to carry over your total balance into the following year. Depending on your provider, your unused funds have a temporary extension, and one of the following will happen:
- 2 ½-month grace period: Your remaining balance remains active for the first 2 ½ months of the new year (i.e., March 15th).
- $570 carryover balance: You can carry over up to $570 in unused funds which expire at the end of next year.
The carryover policy is different for each plan, and you won’t get a choice. Be sure to read your plan guidelines so you can plan your contribution amount accordingly. Thankfully, there are several ways to spend your money on over-the-counter products at the Amazon FSA Store and the FSA Store. You have until December 31st each year to stock up on items without a prescription to legally use up your balance.
Flexible Spending Account Pros and Cons
The Flexible Spending Account has several advantages, but it’s not for everyone. For example, you’re only eligible if your employer offers one. Here’s a closer look at the pros and cons of an FSA:
- Reduces taxable income: Your annual contribution reduces your taxable income dollar-for-dollar even if you don’t file an itemized return.
- Covers many expenses: A medical FSA reimburses most out-of-pocket medical, vision, and dental costs. The dependent care FSA also helps pay your childcare expenses, which can be unavoidable while you work.
- Family medical bills are eligible: While you must have an FSA-eligible health plan to qualify, your FSA contributions can cover bills for your spouse and children.
- Carryover benefits: If your medical bills are less than your original estimate, it’s possible to use your funds next year through a grace period or with a carryover amount.
- Non-refundable contributions: Your FSA balance will expire in the next calendar year. As a result, you might only contribute your average medical bill amount to avoid expiring funds.
- Strict carryover rules: Your employer decides if you can roll over some of your unused funds or if you have a 2.5-month grace period. It’s also possible that your plan may have a use-it-or-lose-it rule where your entire remaining balance expires on December 31st.
- Low annual contribution limit: Individuals and families have the same annual contribution limit. The only way to contribute more is for your spouse’s employer to offer an FSA too.
- Your employer must offer it: You can only open these plans if your employer offers them. If not, you must pay for the expenses out of pocket and may not qualify for a tax deduction.
Both a health savings account and a flexible spending account require an eligible health plan. Either plan covers many of the same medical-related expenses, including dental and vision. However, an HSA has higher contribution limits, your funds don’t expire, and you can open an HSA when your employer doesn’t offer this benefit (assuming you have a high deductible health plan).
No, your contributions are non-refundable and your unused balance expires at the end of the year or when the carryover period ends. To avoid seeing your balance expire, you can book a last-minute medical, dental, or vision appointment. Or, you may also consider buying eligible over-the-counter products like bandages and contact lens solution with your remaining balance.
Your employer may let you roll up to $570 of your unused contributions into next year. If your FSA plan doesn’t have a carryover benefit, a 2 ½ month grace period gives you until mid-March to use up last year’s balance. For 2022 only, any unused funds from 2021 can be carried over and used during 2022 because of special legislation.
No, you cannot itemize FSA-reimbursed medical bills as your contribution reduces your taxable income similar to traditional IRA or 401k contributions. However, this policy is a better benefit for most households as relatively few can itemize.
You may see if your employer can offer these alternatives to an FSA. Your spouse may also contribute to these accounts through their workplace.
Health Savings Account (HSA)
A health savings account (HSA) can be the best tax-advantaged savings account for most households due to their relatively high contribution limits ($3,650 for individuals and $7,300 for families). In addition, you’re eligible if you have a high deductible health plan and can open an account even if your employer doesn’t partner with a provider. Related: Wallet Hacks recommends Lively HSA for its low fees and ease of redemption. See our full Lively HSA review here. In addition to your contributions being tax-deductible, your withdrawals are tax-free for most medical expenses (you can see the HSA withdrawal rules here).
Health Reimbursement Account (HRA)
A health reimbursement account (HRA) is similar to an FSA, but your employer funds your account balance instead of you. You won’t get a tax deduction, but it’s free money as you don’t have to contribute to your account to receive the employer benefit.
Medical Saving Account (MSA)
Medicare beneficiaries may have a Medicare MSA that they can use for Medicare and non-Medicare expenses.
Flexible Spending Account: Final Thoughts
An FSA is an easy way to plan for your typical medical and dependent care expenses. If your employer offers this benefit, consider contributing the usual amount you usually spend on qualifying bills to enjoy the tax savings. When your workplace doesn’t offer this plan, consider asking your HR department to add this benefit or a similar health savings plan.