What Is a Flexible Spending Account? Employer-sponsored savings account known as flexible spending account (FSA) enables employees to use tax-free money to cover a portion of their out-of-pocket medical or dependent care expenses.
How Flexible Spending Accounts Work
When an employer offers an FSA, employees and employers (on the employee’s behalf) may make pre-tax contributions to a flexible spending account. Then, throughout the covered time, employees can either pay out-of-pocket and seek reimbursement, or they can spend the money directly on qualified expenses.
Flexible spending accounts are typically used for expenses related to health, dental care, or child care. The three main categories of FSAs are dependent care, special purpose FSAs (for dentistry and vision), and health care FSAs (also known as health FSAs or medical FSAs) (DCFSA). FSAs for adoption aid are a less popular type of FSA.
Although it is not required by law for employers to offer FSAs, if yours does, you can decide whether to sign up for the program during the annual benefits enrollment period. Then, you will deduct pre-tax money from your paycheck to fund an FSA for upcoming eligible costs.
Let’s imagine you earned $70,000 in gross income for the year and contributed $4,000 to your FSA. Your total income would only be taxed on $66,000. Your payments would go into your FSA before the Social Security and Medicare taxes under the Federal Insurance Contribution Act (FICA), the Federal Unemployment Tax Act (FUTA), or income taxes are deducted.
No of how much you’ve actually contributed, you can use your health care FSA funds at any time during the year. However, only funds that are currently deposited into a dependent care FSA are eligible for reimbursement.
If your workplace offers both, you can participate in both types of accounts, but you must choose and contribute to each one separately.
Your only FSA choice may be a limited-purpose flexible spending account (LPFSA), which only pays for vision and dental costs if you’re also making contributions to a health savings account (HSA).
How To Use FSA Funds
You might get a debit card when you sign up for an FSA so you can use the money in your accounts to pay eligible costs directly. Alternatively, you might pay cash upfront and then request a refund.
To profit from the tax advantages, you might be tempted to make the maximum contributions allowed, but this is often a “use it or lose it” scheme. If you don’t spend the money by the end of the year, the cash in the account could expire.
Employers have the option, but not the obligation, to provide a two-and-a-half-month grace period. As a result, you have more time to use the money. You also have the choice to use your health care FSA as a carrier of a maximum of $610 from 2022 to 2023 instead of a grace period. This is also your employer’s decision.
Flexible Spending Accounts: Example
Let’s look at an example to see how you might contribute to and use money from various types of FSAs. Consider a scenario in which your employer offers both a health care FSA and a dependent care FSA, with yearly limits of $2,750 for the former and $5,000 for the latter. You might choose to contribute $2,000 to each FSA and distribute it evenly over the course of a year.
You have $1,000 saved in each FSA account, and six months into the year, you have reached half of your financing objective. Additionally, you’ve just gotten bills for $2,000 in childcare costs and $1,500 in allowable medical charges.
You can use HCFSA funds at any time during the year regardless of how much you’ve contributed, so even though you only have $1,000 in the account so far, you could instantly request reimbursement for all $1,500 of medical expenses.
However, you can only use the funds that are genuinely available in a DCFSA for dependent care costs. You are currently $500 shy of being reimbursed for the full $2,000 in dependent care expenses, so you would have to wait until you have accrued more contributions.
If your company does not provide a carryover or grace period, make sure to submit your reimbursement request by the end of the plan year to avoid having your funds expire.
What Do Health Care FSAs Cover?
The IRS defines qualifying medical expenses as the costs associated with the diagnosis, treatment, mitigation, and/or prevention of disease for any organ system or bodily function. These consist of:
- payments for professional medical practitioners’ services
- Costs of the necessary tools, materials, and diagnostic tools
- the price of transportation to a medical appointment
- Menstrual care products and over-the-counter medications
A health care FSA cannot be used to pay for insurance premiums, long-term care expenses, or any other expenses that are covered by another health plan.
You and your spouse, your dependent adult family members, or your kid under the age of 27 are all eligible for qualified health expenses. However, dependents who are married and file joint returns or those with gross yearly incomes of more than $4,300 are not included.
What Do Dependent Care FSAs Cover?
qualified costs for caring for dependents Services that enable you or your spouse to work, look for work, or enroll in full-time education are typically covered by FSAs. Before- and after-school care for children, in-home care for dependents, and facility-based daycare are a few typical examples.
These costs must be for a spouse or dependant who is unable to care for themselves, a dependent child under the age of 13 for whom you can claim a tax deduction or both.
Do I Need a Flexible Spending Account?
People who can consistently forecast their annual medical or dependent care costs tend to profit from flexible spending accounts. If you have used daycare over the past 12 months and are certain that you will spend the same amount over the following 12 months, you might want to think about utilizing an FSA.
It may be worthwhile to look into the details of any FSAs that your employer offers to see if participating would be advantageous to you. Think about the choices your employer makes for your FSA, including the contribution cap (your employer can set a lower cap than the IRS permits) or whether it provides a grace period for spending the funds.
Recall that FSA funds have an expiration date. If you can use your contribution within the given time, you’ll benefit the most; if not, you’ll lose money. Utilizing all of your resources reduces your tax liability without affecting your net income.
You must subtract any funds you choose to contribute to a dependent care FSA from the federal tax credit for child and dependent care. Consult with a tax professional to determine which option works best for you.
Frequently Asked Questions (FAQs)
How does a Flexible Spending Account work?
You can fund and use a Flexible Spending Account if your workplace provides a health plan (FSA). You can withdraw money from this account tax-free and use it to pay for medical expenses, such as copayments and deductibles. Your employer isn’t obligated to make a contribution to your FSA, but they may do so if they so desire.
What can I buy with my FSA card?
You can pay directly for FSA-eligible items if you have an FSA debit card. Here is a list of things that are commonly covered by the FSA. You must consult your FSA administrator if you have any questions concerning a particular item. You might be able to get a list from them. Your FSA account will be instantly debited for the amount.
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