Flexible Spending Account (FSA): Meaning, How It Works, Pros & Cons

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A flexible spending account, also known as an FSA, is a tax-advantaged account provided by your employer that enables you to cover dependent care or medical costs.

A Flexible Spending Account (FSA) can help you save a significant amount of money on taxes, depending on how much your health care or dependent care bills are, especially since the list of permissible expenses has grown recently. However, if you contribute more than you use, an FSA could work against you because any unused money might vanish if your company doesn’t roll them over.

Learn more below about FSAs, including what they are, if you should apply for one, and effective ways to use one.

Table of Contents

What Is a Flexible Spending Account (FSA)?

A flexible spending account (FSA) is a sort of savings account that offers its owner particular tax benefits. A flexible spending arrangement, often known as an FSA, can be created by an employer for their staff members. In FSA you can donate a portion of your normal income to the account, and employers are also able to make contributions to employee accounts. The employee must be reimbursed for eligible costs associated with medical and dental treatments using distributions from the account.

An additional type of FSA is a dependent-care flexible spending account, which can be used to cover childcare costs for kids under the age of 12 as well as for the care of eligible adults, including a spouse, who cannot care for themselves and who adhere to certain Internal Revenue Service (IRS) requirements. The maximum contribution limits for medical-related flexible spending accounts and dependent-care FSAs are different.

How Does Flexible Spending Account (FSA) Work?

Flexible Spending Accounts (FSAs) are provided by your employer or place of business. They not only assist you in lowering the amount you owe for certain medical bills, but they also assist you in lowering your tax burden. Let’s imagine your last paycheck totaled $1,000 and your company withheld $50 for your FSA payment. Accordingly, your company determines your taxes owed based on the $950 that you made and deducts them accordingly. Your take-home pay has decreased, which also means that your tax burden has decreased. Keep in mind that only an employer can offer you this plan. You are out of luck if you work for yourself.

During your company’s open enrollment period, you can enroll in an FSA. Normally, this takes place in November or December. It only requires a few pieces of basic information and a choice for your annual contribution amount. Every paycheck has contributions taken out of it. The amount of a deduction is taken out of your gross income because it is pre-tax money.

Nevertheless, there are a few conditions:

You cannot obtain a Flexible Spending Account (FSA) if your employer does not offer one, as they are provided through your place of employment.
People who work for themselves are ineligible.
You cannot change your contribution choice for the year after you’ve made it.
In 2022 and 2023, respectively, an FSA’s annual contribution cap will be $2,850 and $3,050.

Only the items listed in Internal Revenue Service (IRS) Publication 502 are permitted uses of the funds. In general, if your doctor orders a test, medicine, or piece of medical equipment, you can probably pay for it with FSA funds. Moreover, you can pay for:

Dental consultations
Chiropractors
Eyeglasses\sContacts
Hearing aids
Treatment for addiction
Modifications you need to make to your house or vehicle if you or a family member is disabled
Medical services
Publications printed in braille
Some expenses for travel connected to medical care
A guide dog’s education and upkeep

You are not paid for over-the-counter drugs or health insurance fees, among other cost restrictions. So make sure you can use FSA funds before making a major medical purchase.

What Are The Benefits and Drawbacks Of Flexible Spending Accounts?

The benefits and drawbacks of flexible spending accounts are listed below for you to consider if you’re considering it for yourself or your family.

Pros

The family as a whole is eligible for the healthcare FSA benefits: Your flexible spending account, unlike other healthcare benefits, includes your whole immediate family. That covers any adult children up to the age of 26, thanks to the rules of the Affordable Care Act. Through the current configuration of the FSA system, your spouse and young dependents also incur eligible expenses. It’s important to note that you must be able to deduct these people from your income on your tax return; parents who share custody should contact their plan administrator about this. Nevertheless, this is a straightforward way to stretch your income a little further.
You have financial protection for things that insurance may not always cover: Flexible spending accounts for healthcare insurance give you the means to pay for any supplemental care needs that may arise over a year. Certain diagnostic tests travel vaccinations, and over-the-counter medications may not be covered by your insurer. Some expenses, such as the cost of eyeglass frames, call for compensation. In the majority of cases, your FSA can be used to pay for these products.
For simple access to your benefit, most FSAs employ a debit card: Most flexible spending accounts link the funds you have access to through a debit card you can use at approved providers. Simply hand over the card as you would for any other form of payment, and the service provider will process the transaction just like a credit or debit purchase. Although using a vendor that doesn’t accept credit cards, like a preschool, is not made any easier by this benefit, paying for medical expenses is.

Cons

If you lose your job, the benefits end: Flexible spending account monies are directly related to your employer and are therefore always available. As a result, if you end up leaving your employment for any reason, you won’t be able to access your benefits. The annual benefit ceases to exist for you even if you were fired for no fault of your own. Even if you didn’t use the funds for a qualified item before terminating your work, you would still forfeit any FSA contributions you made after your employment ended.
FSAs are only accessible during specific enrollment windows: The majority of flexible spending accounts have a 30-day employer-based signup period. In addition to the first registration period provided to new workers as part of their onboarding process, this is also available. You won’t be given another opportunity to enroll in this benefit until the following open enrollment period if you miss the enrollment deadline. The only situation where this rule does not apply is if you experience a qualifying life event after the deadline has passed, such as getting married, starting a family with your partner, or finalizing an adoption.
Foster families do not enjoy the same benefits: The funds from the flexible spending account cannot be used for the needs of the foster children unless the foster family can declare them dependent. To qualify for a life event for insurance, you would need to adopt the kids in your care. Even though you would still be eligible for other benefits like Medicare and Medicaid, you would still have to pay some costs that are not covered by these plans.

Final Thoughts

When it comes to flexible spending accounts, there is no one-size-fits-all strategy. Forecast your yearly health and dependent care costs, as well as your general drugstore expenditures, and familiarize yourself with the available FSA plans before deciding whether or not one is the best option for you. Read the guidelines for your company’s offers to understand what they cover, and if you need assistance, ask your benefits department.

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