What Is a Flexible Spending Account?
A Flexible Spending Account, commonly called an FSA, is a type of savings account that lets workers set aside pretax money to pay for medical costs. Instead of paying for healthcare expenses with after-tax dollars, employees can contribute money to their FSA before taxes are taken out of their paycheck. This means the money going into an FSA reduces the amount of income that gets taxed, which can result in meaningful savings throughout the year.
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FSAs are offered through employers and are part of a benefits package. The account works by having employees decide how much money they want to contribute during their employer's open enrollment period, typically happening once per year. That amount is divided across paychecks throughout the year. When medical expenses come up, employees can withdraw money from their FSA to cover those costs.
According to the IRS, approximately 30 million Americans have access to FSAs through their employers. However, not all workers use them. Understanding how FSAs work is important because the tax savings can be substantial. For someone in the 24% federal tax bracket, setting aside $2,500 in an FSA saves roughly $600 in taxes annually. State and local taxes can add even more savings, depending on where someone lives.
FSAs differ from Health Savings Accounts (HSAs) and regular health insurance. While HSAs can be carried over year to year and accumulate, FSAs generally operate on a "use it or lose it" basis, meaning unused funds may not carry over to the next year. This is an important distinction that affects how people should plan their contributions.
Practical Takeaway: FSAs are employer-sponsored accounts that reduce taxable income while allowing workers to pay medical expenses with pretax dollars. Learning whether your employer offers an FSA during open enrollment can help you understand this option for managing healthcare costs.
How FSA Contributions and Tax Savings Work
The tax advantage of an FSA comes from the way contributions are structured. When an employee contributes money to an FSA, that money is taken out of their paycheck before federal income tax, Social Security tax, Medicare tax, and usually state and local taxes are calculated. This lowers the total amount of income that gets taxed, which is why FSAs can produce real financial savings.
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Here's a concrete example: Suppose someone earns $50,000 per year and contributes $2,500 to an FSA. Instead of having $50,000 in taxable income, their taxable income becomes $47,500. If that person is in the 22% federal tax bracket, they save $550 in federal taxes alone. When adding state income tax (which varies by location) and payroll taxes, the total savings can exceed $750 for that contribution amount.
The IRS sets contribution limits for FSAs each year. For 2024, the maximum contribution is $3,300 per person per year. For 2025, the limit is $3,300 as well. These limits apply to each individual, not per family, so married couples with FSAs through separate employers can each contribute the maximum amount. Employers can set lower limits if they choose, so it's worth checking what your specific employer allows.
Contributions are divided evenly across all paychecks during the plan year, which typically runs from January through December. This means if someone decides to contribute $2,400 to their FSA and receives 24 paychecks per year, $100 would be taken from each paycheck. The money accumulates in the account and becomes available to spend on covered medical expenses right away.
Practical Takeaway: Calculate your expected medical costs for the upcoming year and use that to decide how much to contribute to your FSA. Contributing only what you expect to spend helps you maximize savings while avoiding the risk of leaving money unused.
Covered Medical Expenses Under FSAs
FSAs can pay for a wide range of medical and healthcare costs, but not every health-related expense qualifies. The IRS maintains a detailed list of what counts as a "qualified medical expense." Generally, these are costs for diagnosis, cure, mitigation, treatment, or prevention of disease, as well as costs for treatments affecting any part of the body's structure or function.
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Common expenses that FSAs cover include copayments for doctor visits, deductibles on health insurance plans, prescription medications, and coinsurance amounts (the percentage of costs patients pay after meeting their deductible). Dental work such as cleanings, fillings, root canals, and orthodontics also qualify. Vision care including eye exams, glasses, and contact lenses can be covered. Mental health and psychiatric care, including therapy sessions and psychiatrist visits, are covered as well.
There are also many smaller expenses that people might not realize qualify. FSA funds can pay for over-the-counter medications such as cold medicine, allergy medication, and pain relievers, as long as they have a prescription or a letter from a doctor stating medical necessity. Supplies like bandages, crutches, hearing aids, and glucose monitors are covered. Medical equipment such as heating pads, air purifiers used for medical reasons, and blood pressure monitors qualify. Some less obvious costs like acupuncture, chiropractic care, and physical therapy also count.
Expenses that do not qualify include cosmetic procedures, general health products like vitamins (unless prescribed by a doctor for a specific condition), gym memberships, and weight loss programs. Toiletries and cosmetics do not qualify, even if they relate to skin care. Long-term care insurance and health insurance premiums generally are not covered through FSAs, though there are limited exceptions.
Practical Takeaway: Review your medical history and anticipated healthcare needs for the year, including dental and vision care, to make an informed decision about FSA contributions. Keeping receipts and understanding what qualifies helps prevent spending FSA funds on non-covered items.
The "Use It or Lose It" Rule and Carryover Options
One of the most important features of FSAs is the "use it or lose it" rule. For most FSA plans, any money that remains unused at the end of the plan year is forfeited and returned to the employer. This means if someone contributes $2,500 but only spends $1,800 on medical expenses during the year, the remaining $700 is lost. This rule exists because of IRS regulations designed to prevent FSAs from becoming retirement savings accounts.
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However, employers do have some options that can provide flexibility. Since 2013, employers have been allowed to offer a grace period of up to 2.5 months after the end of the plan year. This means employees can spend FSA funds on expenses incurred during the grace period, even if the plan year has ended. For example, if the plan year ends December 31, a grace period might extend until March 15 of the following year. This provides some extra time to use accumulated funds for medical expenses.
Another option that employers may offer is an FSA carryover, which allows employees to roll over up to $640 (for 2024 and 2025) of unused FSA funds into the next plan year. Not all employers offer carryover, and the amount varies based on IRS regulations each year. Even with carryover available, most employees will not carry over the maximum amount because they can only carry over what was actually unused.
Because of these rules, careful planning is essential. Employees should estimate their medical expenses conservatively and consider only contributing an amount they are fairly confident they will spend. Factors to consider include upcoming dental work, routine vision exams, prescription medication refills, and anticipated doctor visits. It is better to contribute a smaller amount that will definitely be used than to contribute too much and lose money.
Practical Takeaway: Before contributing to an FSA, ask your employer whether they offer a grace period or carryover option, and plan your contribution amount based on medical expenses you are confident will occur within the plan year.
How to Use Your FSA and Claim Reimbursement
Once you have set up an FSA through your employer, accessing the funds is straightforward. Most FSAs provide a debit card that can be used to pay for covered medical expenses at the point of service. For example, you can use the FSA debit card to pay your copayment at your doctor's office, pay for prescription medications at the pharmacy, or pay for dental work at your dentist. The amount is deducted directly from your FSA balance.