Health Flexible Spending Accounts (FSAs) are a type of Medical Reimbursement Plan. Health FSAs are one way for employees to use pre-tax dollars to pay for medical expenses, such as doctor visit copays, vision expenses, and prescription drug costs. FSAs are established by employers, and are (usually) 100% employee funded.

Health FSAs are a popular way to pay for medical expenses tax-free. It’s estimated that 14 million American families use FSAs, with the average employee contribution $1,484 a year (2012).

The sections outlined on our navigation bar provide more information about Flexible Spending Accounts.

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FSA Pros and Cons

When evaluating Health Flexible Spending Accounts, consider these pros and cons.

Health Flexible Spending Accounts - Pros

Employee Tax Savings

Employees contribute to their FSA through payroll deductions, taken out on a pre-tax basis. This means the money is deducted from pay before taxes have been withheld. Thus, employees’ taxable income is lowered, which in turn reduces the amount of taxes paid. This also means employees save on the cost of medical care, because they use pre-tax dollars.

Employer Tax Savings

Employers also save money with FSAs by not paying wage taxes on FSA contributions. Each $100,000 of salary foregone by employees in favor of FSA contributions saves an employer $7,650 (7.65%) in FICA and FUTA taxes.

Medical Savings

Health FSAs allow employees to save for anticipated medical savings throughout the year.

Full Balance Available on Day One

As a benefit to employees (but a “con” for employers), employees’ full annual contribution amount is available on day one. Employees can withdraw funds from the FSA to pay for qualified medical expenses, even if they have not yet placed the funds in the account.

Health Flexible Spending Accounts - Cons

Annual Contribution Limits

With Health FSAs there is an annual contribution maximum which limits how much you can contribute each year ($2,550 in 2015).

Limited Rollover

A drawback of Health FSAs is there is limited (or no) annual rollover. Employers may allow up to $500 to roll over at the end of the year, otherwise any unused funds are forfeited at the end of the year.

Not Portable

Unlike Health Savings Accounts (HSAs), Health FSAs are tied to employment, and are not maintained if the employee is no longer working for the employer.

Flexible Spending Account Use Cases

How Flexible Spending Accounts are Used

Flexible Spending Accounts (FSAs) are an employer-established health benefit that allows employees to use pre-tax dollars for out-of-pocket medical expenses, dependent (child) care expenses, and adoption expenses.

Depending on your individual income tax bracket, employees save a combined 18% - 50% federal, state, and local income and wage taxes on medical expenses funded through an FSA. Employees also receive the intangible benefits of having funds for anticipated out-of-pocket medical expenses available through forced payroll savings.

3 Types of Flexible Spending AccountsFlexible_spending_accounts

There are three types of Flexible Spending Accounts: Health FSAs, Dependent Care FSAs, and Adoption FSAs.

1. Health FSA

The most common type of FSA is a Health FSA, also known as a Medical FSA. A Health FSA allows employees to use pre-tax dollars for out-of-pocket medical expenses such as doctor co-pays, prescriptions, deductible expenses, and other eligible medical expenses. The maximum annual contribution limit for Health FSAs is $2,550 (2015).

For example: An employee elects to contribute pre-tax wages to an FSA in the amount of $200/month. On the first day of year, the employee receives a $2,400 FSA allowance for medical expenses. The employee has access to the full $2,400 on the first day of the plan year. The employee may use their FSA to pay (or be reimbursed) for qualified medical expenses.

2. Dependent Care FSA

A Dependent Care FSA, or Child Care FSA, allows employees to pay for employment-related dependent care services on a pre-tax basis. The maximum annual contribution limit for Dependent Care FSAs is $5,000 (2015).

Unlike a Health FSA, with a Dependent Care FSA funds are only available that have already been contributed through payroll deduction. In other words, the full year’s election is not available on day one of the plan year.

For example: With a Dependent Care FSA, an employee elects to contribute pre-tax wages to a Dependent Care FSA in the amount of $400/month in 2015. The employee has access to the funds that have accumulated in the FSA via payroll deductions (Ex: $400 on January 1). The employee may use their FSA to pay (or be reimbursed) for qualified dependent care.

3. Adoption FSA

A lesser known FSA option is an Adoption FSA. With an Adoption FSA, employees can set aside pre-tax money to use on expenses incurred while adopting a child.

Tip: In this guide on Flexible Spending Accounts, we focus on Health FSAs.

Health Flexible Spending Accounts - Key Features

To better understand how Health FSAs are used, here is a summary of key features:

  • FSAs must be established by the employer.

  • FSAs are usually 100% employee funded, but an employer may contribute.

  • The maximum annual contribution is $2,550 (2015), with annual inflation increases.

  • FSA contributions are made with pre-tax payroll deductions.

  • FSA funds may be used on any unreimbursed medical care expenses, as defined by the IRS (see Publication 502). Health insurance premiums are not an eligible expense.

  • If the employer allows, a maximum of $500 FSA funds may be carried over year to year. Otherwise, the funds are “use it or lose it.”

  • FSAs are tied to employment, and are not maintained if the employee no longer works for the employer.

  • FSA expenses must be substantiated. An FSA debit card is a popular feature.

FSA Rules and Requirements

This section outlines Health Flexible Spending Account (FSA) rules and requirements.Flexible_spending_accounts_rules_requirements

Health FSA Eligibility

To be eligible for a Health FSA:

  • Your employer must offer an FSA.

  • You must elect enrollment and elect an FSA contribution amount.

  • You do not have to be covered under any other health plan to participate.

Note: Self-employed persons are not eligible for FSAs.

FSA Contribution Rules

Contribution Amounts

For calendar year 2015, the annual FSA contribution limit is $2,550.

Who Contributes

With an FSA, the employee or employer may contribute, though usually it is 100% employee-funded. FSA contributions are made through a Section 125 Cafeteria Plan.

When to Contribute

At the beginning of the plan year, employees must designate how much they want to contribute. Then, the employer deducts the amounts periodically (generally, every payday) in accordance with the annual election. Consistent with other Cafeteria Plan rules, employees can change or revoke elections only if there is a change in employment or family status that is specified by the plan.

FSA Rollover Rules

In the past, FSAs were “use it or lose it,” meaning unused funds were completely lost at the end of the plan year. However, employers now have a choice of allowing employees to:

  • Allow a carryover up to $500 year to year (a limited rollover), or

  • Allow a 2.5 month grace period for spending down FSAs, or

  • Neither

Tip: The FSA rules are outlined in IRS Publication 969, and contribution maximums are adjusted annually by the IRS.

FSA Frequently Asked Questions

This section answers frequently asked questions (FAQs) about Health Flexible Spending Accounts (FSAs).

How Do I Qualify for a Health FSA?

To qualify for a Health FSA, your employer must offer the benefit and you must elect participation.

How Much Can I Contribute to My Health FSA?

In 2015, you may contribute up to $2,550 annually.

How Can I Use My FSA Money?

You may spend your FSA money tax-free on out-of-pocket medical expenses, such as your deductible, co-payments for medical care and prescription drugs, or bills not covered by insurance such as vision and dental care.

The IRS determines the types of medical expenses you can use tax-free with FSA funds. They are listed in IRS Publication 502.

How Does Health Reform Change FSAs?

The Affordable Care Act ("health reform") was signed into law in 2010 and made two key changes to FSAs:

  • As of 2011, over-the-counter medications are no longer eligible for tax-free withdrawal unless obtained with a prescription (except for insulin).
  • As of 2013, Health FSA employee salary reduction contributions limited to $2,500 per plan year, with future increases to allow for inflation.

What is the Difference between an HRA, HSA, and FSA?

Health Reimbursement Arrangements (HRAs), Health Savings Accounts (HSAs), and Flexible Spending Accounts (FSAs) are all types of Medical Reimbursement Plans. However, each type has different benefits and requirements for employers and employees.

For a detailed overview of the benefits and requirements of HRAs, HSAs, and FSAs see:

Medical Reimbursement Plans Comparison Chart

How Does a Company Administer a Health FSA?

Most companies hire a third party administrator to set up and help administer the Health FSA.

Do you have additional questions on Flexible Spending Accounts? Contact us. We’d be happy to help.

Additional Reading on Flexible Spending Accounts

2015 FSA Annual Contribution Limit

The IRS recently set the 2015 annual contribution limit for health Flexible Spending Accounts (FSAs). The maximum election amount for FSAs in 2015 is $2,550, up $50 from 2014. Read more.

HRAs, HSAs and FSAs in 2014 - Changes Under Health Reform

The Affordable Care Act (known as ACA, ObamaCare, or health reform) was signed into law in 2010 and impacts many areas of health care and health insurance, including medical reimbursement programs such as HRAs, HSAs, and FSAs. This article reviews how HRAs, HSAs, and FSAs are impacted by health reform. Read more.

FAQ: Can I have an HRA and FSA at the same time?

This articles answers how you can have an HRA and FSA at the same time. Read more.

FSA Balance Rollover and HSA Contribution Rules

This article provides an overview of HSA and Health FSA compatibility. Read more.

The Comprehensive Guide to the Small Business HRA