Flexible Spending Account (FSA) is a type of savings account that allows you to set aside money from your paycheck before taxes to pay for certain out-of-pocket expenses related to health care or dependent care.
By using an FSA, you can lower your taxable income and save money on taxes. In this article, we will explain how an FSA works, what are the benefits and drawbacks of using one, and how to make the most of your FSA funds.
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What Is an FSA and How Does It Work?
An FSA is an employer-sponsored benefit that lets you contribute a portion of your regular earnings to an account that you can use to reimburse yourself for qualified expenses. There are two types of FSAs: a health care FSA and a dependent care FSA.
- A health care FSA covers medical, dental, vision, and prescription drug expenses that are not paid by your health insurance plan or any other source. Examples of eligible expenses include deductibles, copayments, coinsurance, eyeglasses, contact lenses, hearing aids, braces, and over-the-counter medicines with a doctor’s prescription.
- A dependent care FSA covers child care or adult care expenses for dependents who live with you and meet certain requirements. Examples of eligible expenses include daycare, preschool, after-school programs, summer camps, nanny services, and elder care.
You can enroll in an FSA during your employer’s open enrollment period or when you experience a qualifying life event, such as marriage, divorce, birth, adoption, or change in employment status. You can choose how much to contribute to your FSA each year, up to the IRS limits. For 2023, the annual contribution limit for a healthcare FSA is $3,050 per employee. For a dependent care FSA, the limit is $5,000 for married couples filing jointly or single parents, and $2,500 for married couples filing separately.
The money you contribute to your FSA is deducted from your paycheck before taxes are withheld. This reduces your taxable income and your tax liability. For example, if you earn $50,000 a year and contribute $2,000 to a health care FSA and $3,000 to a dependent care FSA, your taxable income will be reduced by $5,000. This means you will pay less in federal income tax, Social Security tax, Medicare tax, and state income tax (if applicable).
To use your FSA funds, you need to submit a claim to your FSA administrator (usually your employer or a third-party vendor) with proof of the expense and a statement that it has not been covered by any other source. You can either pay for the expense out of pocket and get reimbursed later or use a debit card linked to your FSA account to pay directly at the point of service. You can submit claims throughout the year as long as they are for expenses incurred during the plan year.
What Are the Benefits of Using an FSA?
Using an FSA can help you save money on health care and dependent care costs in several ways:
- You can lower your taxable income and pay less in taxes. Depending on your tax bracket and state tax rate, you could save up to 40% or more on every dollar you contribute to an FSA.
- You can use pre-tax dollars to pay for expenses that are not covered by your health insurance plan or any other source. This can help you reduce your out-of-pocket costs and afford better quality care.
- You can use your FSA funds throughout the year as long as they are for expenses incurred during the plan year. This gives you flexibility and convenience in managing your cash flow and budget.
- You may receive additional benefits from your employer if they choose to contribute to your FSA or offer other incentives. For example, some employers may match a percentage of your contributions or provide wellness programs that reward you for using preventive care services.
What Are the Drawbacks of Using an FSA?
Using an FSA also has some drawbacks that you need to be aware of:
- You must use the money in your FSA by the end of the plan year or risk losing it. This is known as the “use it or lose it” rule. However, some employers may offer one of two options to help you avoid forfeiting unused funds:
- A grace period of up to 2 1/2 months after the end of the plan year (until March 15) to use the remaining balance in your FSA.
- A carryover option that allows you to roll over up to $610 of unused funds into the next plan year.
- You cannot change your contribution amount during the plan year unless you experience a qualifying life event. This means you need to plan carefully how much to contribute based on your expected expenses for the year.
- You cannot use a health care FSA if you have a high-deductible health plan (HDHP) and a health savings account (HSA). An HSA is another type of tax-advantaged account that lets you save and pay for health care costs. However, an HSA has different rules and benefits than an FSA. You can learn more about HSAs here.
- You cannot use a dependent care FSA for expenses that are eligible for the child and dependent care tax credit. This is a federal tax credit that reduces your tax liability based on your income and the amount you spend on child care or adult care. You can learn more about the child and dependent care tax credit here.
How to Make the Most of Your FSA Funds
To maximize the benefits of using an FSA, here are some tips to follow:
- Estimate your health care and dependent care expenses for the year based on your past spending, your current needs, and your future plans. Consider any changes in your health status, family size, insurance coverage, or income that may affect your expenses.
- Choose the type and amount of FSA that best suits your situation. If you are eligible for both a health care FSA and a dependent care FSA, you can enroll in both and contribute up to the IRS limits for each one. However, you cannot use funds from one FSA to pay for expenses that are eligible for the other FSA.
- Review the list of eligible expenses for each type of FSA and keep track of your receipts and documentation. You can find a comprehensive list of eligible expenses for a health care FSA here and for a dependent care FSA here. You will need to provide proof of the expense and a statement that it has not been covered by any other source when you submit a claim to your FSA administrator.
- Use your FSA funds throughout the year as long as they are for expenses incurred during the plan year. Do not wait until the end of the year to use up your balance or you may miss the deadline or incur unnecessary expenses. If your employer offers a grace period or a carryover option, take advantage of it if you have unused funds left in your FSA.
- Monitor your FSA account regularly and check your statements for accuracy. You can usually access your account online or through a mobile app provided by your FSA administrator. You can also contact them if you have any questions or issues regarding your account.
In conclusion, A flexible spending account (FSA) is a valuable benefit that can help you save money on health care and dependent care costs. By contributing pre-tax dollars to an FSA, you can lower your taxable income and pay less in taxes. You can also use your FSA funds to pay for expenses that are not covered by your health insurance plan or any other source. However, using an FSA also has some drawbacks, such as the “use it or lose it” rule, the contribution limits, and the eligibility restrictions. Therefore, you need to plan carefully how much to contribute to an FSA and how to use your FSA funds wisely.
Frequently Asked Questions (F&Qs)
How do you qualify for FSA?
To qualify for a Flexible Spending Account (FSA), you must have a health plan through a job. An FSA is a special account you put money into that you use to pay for certain out-of-pocket health care costs. You don’t pay taxes on this money, which means you’ll save an amount equal to the taxes you would have paid on the money you set aside. Employers may make contributions to your FSA, but they aren’t required to. You can use funds in your FSA to pay for certain medical and dental expenses for you, your spouse if you’re married, and your dependents. You can’t use a Flexible Spending Account with a Marketplace plan. Instead, a similar product called a Health Savings Account (HSA), allows you to set aside money on a pre-tax basis to pay some health expenses if you have a “high deductible” Marketplace health insurance plan.
What is FSA and HSA mean?
FSA stands for Flexible Spending Account, and HSA stands for Health Savings Account. Both are tax-advantaged accounts that allow you to save money for certain medical or wellness expenses. An FSA is an employee benefit that allows you to set aside money, on a pre-tax basis, for certain health care and dependent care expenses. On the other hand, an HSA is a savings account linked to a high-deductible health insurance plan. The money you put into your HSA is not subject to income tax and can be used to pay for everyday medical costs, such as over-the-counter pain relievers, as well as for yearly expenses, such as vision exams.
Flexible Spending Account (FSA)