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FSA Guide

This guide covers a few different types of FSAs, how they work, and what you can do to use these employer benefits to help reduce the cost of some everyday expenses.

In this guide to FSAs, we answer all of those questions and more. So whether you’re an employer who may want to offer an FSA, you’re an employee interested in this benefit, or maybe you have an FSA and need a little help understanding how best to use it, this guide will walk you through the necessary information.

What is an FSA?

a person sitting at a desk looking at their laptop

An FSA is an account offered by an employer, to which employees can contribute pre-tax dollars from their paycheck in order to pay for medical care, supplies and other services. Employers can also contribute money to employees’ FSAs but aren’t required to do so, and, it’s important to note, employer contributions count toward employees’ maximum annual contributions. Annual maximum contribution limits vary for each type of FSA as do the rules for how and what you can spend the contributions on.

There are different types of FSAs and each type can only be used for a specific purpose. The three we cover in this guide are:

Healthcare FSAs

Employers can offer Healthcare FSAs to help employees pay for eligible medical, dental and vision expenses their insurance plans don’t cover. Unlike HSAs, FSAs don’t need to be paired with a specific health insurance plan, which is good news as employees have more freedom to choose the health plan that works for them. But like HSAs, there are particulars to FSAs that employers and employees alike must be aware of.

Characteristics of a Healthcare FSA

Eligibility. Someone is only eligible to open and contribute to an FSA if their employer offers one.
Contribution limits. Whether they’re an individual or a member of a family of four, an employees’ contributions combined with their employers’ cannot exceed $3,050 in 2023 and $3,200 in 2024. In This may not seem like a lot given how expensive medical care can be, but any unused funds are forfeited at the end of the year so it’s wise to encourage employees to budget only for what they think they’ll need.
Rollovers, etc. Employers have the option of rolling over up to $610 in 2023 and $640 in 2024, or they can provide a 2.5 month grace period during which employees can spend their remaining contributions. But they can’t offer both.
Can employees change the amount they contribute? Employees must choose their annual contribution amount at the beginning of the plan year and then the employer deducts the appropriate amount each month. Employees can only change their election if there is a change in their employment or the “family status” that is specific to their health plan.
Can employees also have an HSA? In order to open an FSA, you must also stop contributing to your active HSA, if you have one. You can still use your HSA funds to pay for qualified medical expenses if you have an FSA, but since you forfeit any unused FSA funds at the end of the calendar year, it makes sense to spend your FSA dollars first.

What can Healthcare FSA's be used for?

Some qualified medical expenses for Healthcare FSAs include:

Copays
Some prescriptions
Deductibles
Over-the-counter drugs as long as the employee’s doctor has given them a prescription for said drugs (insulin refills don’t need a prescription)
Medical supplies and equipment like crutches and bandages
Diagnostic devices like blood sugar kits

Contributions to a Healthcare FSA can be used to cover:

Employees
Employees Spouses
Employees Dependents, including children under the age of 27

There are some things FSAs cannot be used for:

FSA contributions cannot be used for:

Insurance premiums
Long-term care coverage
Any expenses covered under another health plan

Important Healthcare FSA Tax Information:

Contributions into an FSA (from both employee and employer) are NOT subject to federal or state income taxes, nor are they subejct to the employee portion of payroll taxes.

For a Healthcare FSA to maintain its tax-qualified status, the company must follow IRS rules for cafeteria plans and highly compensated and key employees. That means the following individuals MUST have their FSA contributions included in their gross taxable income:

Any officer of the company making more than $180,000
Anyone who owns 5% or more of the business
Anyone who owns 1% or more of the business AND has an annual salary of $150,000 or more.

The upside? You don't need to fill out any special tax forms if you have a Healthcare FSA.

Dependent Care FSA

illustration of a man and woman under an umbrella

A Dependent Care FSA is a pre-tax account offered by employers to help employees save and pay for child and dependent care. It's meant to help employees pay for services that allow them to work when they would otherwise need to be at home, fulfilling caretaking duties.

One of the major benefits of this FSA? You can contribute to this type of FSA and a health savings account (HSA) at the same time with no penalties.

Unlike Healthcare FSAs, Dependent CARE FSAs are not front-loaded. This means that you fund the account throughout the year with each deduction from your paycheck, and you can use the money once it’s deposited into the account.

How to be Eligible for a Dependent Care FSA

The eligibility rules for a Dependent Care FSA are somewhat complex:

Like all FSAs, someone can only open and contribute to a Dependent Care FSA if their employers offer it as a benefit.
To open a Dependent Care FSA, you must have at least one of the following living with you full time: a child who is under the age of 13 or a spouse or relative who is physically or mentally incapable of taking care of themselves.
If the employee and their spouse are divorced, only the spouse with primary custody may contribute to this type of FSA.
If the employee is married, both spouses must work and earn income unless one spouse is disabled and unable to work.
If employees don't follow these rules, the money they and the company contribute to their FSA will be forfeited and they will have to pay income taxes on the forfeited amount.

Dependent Care FSA Contribution Limits

In 2023 and 2024, employees may contribute up to $5,000 if they file taxes as an individual, or are married filing jointly. They may contribute up to $2,500 if they're married but file taxes separately (each spouse can contribute $2,500 to separate FSAs).

Changing Contribution Amount

Employees participating in the Dependent Care FSA must choose their allocation at the beginning of the calendar year and can only change their allocation within 31 days of a qualifying event (e.g. birth of a child, adoption, death of a dependent, divorce, change of employment, etc.)

Qualified Expenses for a Dependent Care FSA

Acceptable Dependent Care FSA expenses include:

Physical care
In-home care, such as an au pair, nanny, or babysitter
Care in an institutional setting like child or adult daycare given by qualified caregivers
Transportation provided by caregivers
Application fees, deposit, etc. required for obtining care (but only if care subsequently provided)

You Can't Use a Dependent Care FSA for all care:

A Dependent Care FSA is a great asset to have if you have kids or other dependents, but it can't be used for ALL care. Here are a few things it CANNOT be used for:

Babysitting that is provided by a sibling or child under the age of 19, or another individual who can be claimed as a dependent
Education, such as private school or tutoring
Overnight camps
Enrichment activities like sports or music lessons
Custodial nursing care or long-term care for parents not living with employees taking the FSA benefit
Housekeeping

The Benefits of a Dependent Care FSA

Not only do they lower employees’ tax burdens, they could enable employers to keep good employees in their workforce. The high cost of childcare and care for parents and other dependents could lead employees to think it’s not worth the cost to keep working. But if they could pay for this care with pre-tax dollars (or even with a contribution from their employer), they might feel more incentivized to stay in the workforce.

Important Tax Information:

If employees do contribute to a Dependent Care FSA, they will need to complete and submit IRS Form 2441 when they file their taxes.

Limited Purpose FSA

Contributions to Limited Purpose FSAs can only be used for dental and vision expenses that employees’ health plans don’t cover. The rules for these accounts are similar (but not exactly the same) as the Healthcare FSAs.

How to Be Eligible for a Limited Purpose FSA

The only way that someone is eligible for a Limited Purpose FSA is if their employer offers it as a benefit to their employees.

Limited Purpose FSA Contribution Limits

The 2023 contribution limit for employees for a Limited Purpose FSA is $3,050 and $3,200 for 2024.

Similar to Healthcare FSAs, employers have the option of rolling over up to $610 of unused FSA funds in 2023 and $640 in 2024, or they can provide a 2.5 month grace period during which employees can spend their remaining contributions - however they cannot over both. It's only one or the other.

Changing Contribution Amount

Employees must choose their annual contribution amount at the beginning of the play year and then the employer deducts the appropriate amount from their paycheck pre-tax every month. Employees can only change their election if they have a qualifying life event.

Qualified Expenses for a Limited Purpose FSA:

Qualified medical expenses for Limited Purpose FSAs include:

Eye glasses, contacts, and solution
Braille books and magazines
Copays
Deductibles
Office visits
Diagnostic services
Non-cosmetic surgery for detal care and reconstruction
Dentures and bridges
Eye exams
Drug treatments (both prescription and over-the-counter)
Guide dogs (dog, training, care)
Eye surgery (including laser and LASIK)
Orthodontia
Guards for teeth grinding
X-rays
Transportation expenses to receive care

What you CANNOT use your Limited Purpose FSA for:

FSA distributions cannot be used for the following expenses:

Health insurance premiums
Long-term care coverage or expenses
Anything covered under another health plan

How Do FSAs work?

FSAs are funded through employer transfers that they deduct from their employee's monthly paychecks. The process goes like this:

Employer front loads the funds for employee FSAs.
The employer then deducts the contribution amount that the employee elects from the employee's paycheck.
Those funds are then held in the company's bank account to use.

How are FSA Funds Distributed?

There are two main ways that FSA funds are distributed:

Debit cards: If the employer has set up the FSA with a debit card, employees have direct access to their funds and can pay for expenses at the point-of-sale without needing to submit receipts or other documentation.

Reimbursements: If the employer hasn’t given employees direct access to their funds, employees will need to pay for their expenses first, then submit the proper documentation to the FSA administrator for reimbursement. Reimbursements can come in the form of direct deposits to employees’ bank accounts or checks mailed to their address.

Important Note:

An FSA CANNOT make advance distributions. So if an employee knows they have an expense forthcoming, they will either need to use their FSA debit card to pay for their out-of-pocket expenses at the point-of-sale, or they will need to pay first, then get reimbursed.

As you can see, FSAs can help make medical and dependent care more affordable for employees. They can keep employees healthier and in the workforce, which means they’ll be more productive, and they can help you attract top talent. So with FSAs, everybody wins.

Disclaimer: the content presented in this article are for informational purposes only, and is not, and must not be considered tax, investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, including fund prospectuses, and consult with appropriate tax, investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.

Frequently asked questions

How much can I contribute to a health FSA?

Flexible Spending Account contribution limits are set annually by the IRS. In 2022 the limit is $2,850 and in 2023 the limit is $3,050 but an employer can choose to set a lower limit. Both an employer and employee can contribute to an FSA.

Unlike a Health Savings Account, there are no family contributions. However, both spouses or partners can have individual FSAs eligible up to the annual maximum contribution limit each or up to their respective employers’ set limits. On top of that, employers can match employee FSA contributions. Employers may contribute additional funds up to the annual limit per individual FSA account. There are some complexities here (for example, what an employer can match if the employee contributes less than $500 dollars). See full details here.

What can I use my FSA funds for?

Employees can use FSA funds to pay for any medical related expenses like copays, deductibles and other out-of-pocket costs. See full list here. Unlike a Health Savings Account, the full FSA fund amount is available for use on the first day of the plan year, rather than accumulating throughout the year.

How is my FSA funded?

FSAs are funded through payroll deductions. The full amount of our FSA is available immediately at the employees plan start date. The employer then deducts the contribution amount that the employee elects from the employee's paycheck.

What does it mean to substantiate an expense?

FSAs require that every expense is approved by the plan sponsor (typically your employer). This is because your employer is putting in place a plan that walks through all eligible expenses that the plan is allowed to pay for.

If you (as the employee) are utilizing pre-tax FSA funds on expenses that are not approved by the IRS, your employer could face penalties and fines by the IRS for non-compliance. As a result, if they can’t, with confidence, know that you spent your funds on qualified medical expenses, they will ask you for further documentation or proof so that the use of those funds were “substantiated”. This is what gives them the protection they need in case of an IRS audit.

Is an FSA tax-free?

Yes, employees elect how much to contribute into the account at the beginning of each plan year. Then, the total annual amount is deducted from the employees’ paycheck equally throughout the year. Any employer contributions are also tax-free.

Who can enroll in an FSA?

Most full-time employees are eligible to enroll in their employer’s FSA. An employee does not need to enroll in the employer’s healthcare to be eligible to enroll in their FSA. An FSA is not a healthcare plan but can be used in conjunction with a healthcare plan in the US.

Do my FSA funds rollover at the end of the year?

After year-end, any money left over in an employee FSA will be turned over to the employer with three small exceptions (these are are at the discretion of the employer):

Grace Period: An additional two and a half months (until March 15th assuming a plan year that starts on January 1st) is granted to the employee for any new expenses that can be used from money in the FSA from the prior year. After the grace period, any remaining money will be turned over the employer.
Carry-Over: Employees can roll over a maximum of $570 (in 2022) and $610 (in 2023) from plan year to plan year if allowed by his/her employer. Any additional dollars above the roll over maximum will be forfeited. Please note, any funds that are rolled over from the previous year do not count towards the current year pre-tax contribution limit set by the IRS.
Run-Out Period: This is the additional time, after the plan year ends, tha an employee can file a claim that occurred in that plan year.

An employer can only provide one of these two options (grace period or carry-over) at the end of the year - not both.

What happens to my FSA if I leave my job?

Once an employee leaves a job, any unused FSA funds will be returned to the employer. However, employees will have 90 days to submit any outstanding FSA eligible expenses.

What are Medical (Healthcare) FSA, Limited-Purpose FSA and Dependent Care FSA?

Medical (aka Healthcare) FSAs help employees pay for eligible medical, dental and vision expenses their insurance plans don’t cover. Unlike HSAs, FSAs don’t need to be paired with a specific health insurance plan, which is good news as employees have more freedom to choose the health plan that works for them.

Limited-Purpose FSAs can only be used for dental and vision expenses that employees’ health plans don’t cover. The rules for these accounts are similar (but not exactly the same) as the Healthcare FSAs. One of the major benefits of this FSA? You can contribute to a Limited-Purpose FSA and a health savings account (HSA) at the same time with no penalties.

A Dependent Care FSA is offered by employers to help employees save and pay for child and dependent care. It's meant to help employees pay for services that allow them to work when they would otherwise need to be at home fulfilling caretaking duties.

How is an FSA different from an HSA?

While both accounts can be used for qualified medical expenses, there are significant differences. A Flexible Spending Account (FSA) is fundamentally different from a Health Savings Account (HSA).

An FSA is a “use it or lose it” spending account, meaning you have a limited amount you can contribute each year, but if you don’t use the money in it, you will lose the ability to use it later (subject to limited carry forwards and a grace period). With an FSA, the account is also not yours, it is your employer’s. Additionally, you have to make an election at the beginning of each Plan Year to determine how much money you want to put away. An FSA can be used with almost any type of health insurance (low or high deductible).

An HSA on the other hand is your account and it is portable. Meaning if you decide to leave your employer, you can take all of the money in your account with you. You can also rollover your balances year-to-year, so there is no concept of “use it or lose it”. The contribution limits are also higher with an HSA versus an FSA, and you can make adjustments throughout the year. In addition to helping you save on qualified expenses, an HSA also accrues interest tax-free, and the funds can even be invested tax-free. Contributions to an HSA can only be made with an active qualifying Health Deductible Health Plan.