Flexible Spending Accounts (FSAs – Use It or Lose It)
What is a Flexible Spending Account (FSA)?
An FSA is an employer-sponsored benefit allowing employees to set aside money from their paychecks on a pre-tax basis to pay for eligible out-of-pocket healthcare or dependent care expenses. By using pre-tax dollars, you effectively lower your taxable income and save money on costs you’d likely incur anyway. Unlike HSAs, FSAs generally have a “use it or lose it” rule each year. Sarah used her Health FSA to pay for her glasses and dental fillings, saving about 30% on those costs due to the tax advantage.
Who Offers FSAs? (Employer-Based Benefit Only)
FSAs are only available through employers as part of their benefits package. You cannot open an FSA independently if your employer doesn’t offer one. Not all employers offer FSAs, though they are common, especially in larger companies. Enrollment typically happens during the employer’s annual open enrollment period. When starting his new job, Mark was pleased to see they offered both a Health FSA and a Dependent Care FSA as optional benefits he could elect.
How Do FSAs Work? (Pre-Tax Contributions for Medical Expenses)
During your employer’s open enrollment, you elect an annual amount to contribute to the FSA (up to the IRS limit). This total amount is divided evenly and deducted pre-tax from each paycheck throughout the year. The full elected annual amount is usually available for you to use from day one of the plan year, even before all contributions have been made. Jane elected $1,200; $100 was deducted pre-tax monthly, but she could use the full $1,200 for a dental procedure in February.
The “Use It or Lose It” Rule: The Biggest Downside of FSAs
This is the defining characteristic and major drawback. Generally, funds contributed to an FSA must be spent on eligible expenses incurred within that same plan year. Any money left unspent in the account at the end of the plan year (or associated grace period/rollover deadline) is forfeited back to the employer. You lose it. This forces careful planning to avoid contributing more than you can spend. Peter over-estimated his expenses and forfeited $150 left in his FSA at year-end.
FSA Grace Periods and Rollover Options (Limited Choices by Employer)
To mitigate the strict “use it or lose it” rule, employers can offer one of two options (not both): 1. A Grace Period: Allows an extra 2.5 months after the plan year ends to incur expenses and use remaining funds. 2. A Rollover: Allows carrying over a limited amount (up to $640 for 2024 plan years ending in 2025) into the next plan year. Check your employer’s specific plan details! Maria’s employer offered the $610 rollover, which saved her from losing the balance she hadn’t spent.
Qualified Medical Expenses for FSA Reimbursement
Health FSA funds can be used for a wide range of medically necessary expenses not covered by insurance. This includes deductibles, copays, coinsurance, prescription medications, dental treatments (exams, fillings, braces), vision care (exams, glasses, contacts, LASIK), medical equipment (crutches, blood sugar monitors), chiropractic care, therapy, and eligible over-the-counter items. Cosmetic procedures are generally excluded. Ben used his FSA to cover his deductible costs and prescription copays throughout the year.
Using FSA Funds for Over-the-Counter Items (Receipts Needed!)
Yes, many common over-the-counter (OTC) health items are FSA-eligible without needing a prescription. This includes pain relievers, cold/flu medicine, allergy products, antacids, first aid supplies (bandages, antiseptic wipes), sunscreen, thermometers, and menstrual care products. However, you must keep detailed receipts as proof of purchase for reimbursement or if using an FSA debit card that requires substantiation. Lisa bought $50 worth of eligible OTC items at CVS using her FSA funds during her year-end spending push.
The CVS Webpage Strategy: Spending Down Your FSA
As the video mentioned, retailers like CVS often have dedicated webpages listing FSA-eligible items. This is helpful near the end of the plan year if you have remaining funds facing the “use it or lose it” deadline. You can browse the eligible OTC products (first aid, pain relief, etc.) and stock up on items you’ll eventually use to avoid forfeiting your pre-tax dollars. Realizing he had $80 left in his FSA in December, Mark used the CVS site to find eligible items like sunscreen and pain relievers to buy.
FSAs vs. HSAs: Which is Better? (Depends on Eligibility/Needs)
HSAs are generally superior due to fund rollover, portability, and investment potential, but require HDHP coverage. FSAs don’t require an HDHP and make the full annual amount available upfront, but funds expire yearly and are tied to the employer. If eligible for an HSA (have HDHP), it’s usually the better long-term choice. If you have a traditional low-deductible plan, an FSA is the only option for pre-tax health spending. The best choice depends entirely on your health plan eligibility and savings goals.
Limited Purpose FSAs (For Dental/Vision, Usable with HSA)
If you have an HSA-qualified HDHP, you cannot have a general-purpose Health FSA. However, your employer might offer a Limited Purpose FSA (LPFSA). This type of FSA can only be used for eligible dental and vision expenses. This allows HSA holders to gain additional pre-tax savings specifically for dental/vision costs while preserving their main HSA funds for medical expenses or investment growth. Already maximizing his HSA, Tom also contributed to his employer’s LPFSA to cover his family’s anticipated orthodontia costs tax-free.
Dependent Care FSAs (Separate Account for Childcare Costs)
Separate from Health FSAs, employers may offer Dependent Care FSAs (DCFSAs). These allow you to set aside pre-tax money specifically to pay for eligible childcare expenses (daycare, preschool, summer camp) for children under 13, or care for other qualifying dependents, that enable you (and your spouse, if married) to work or look for work. Contribution limits are different ($5,000/household typically). The Parkers used their DCFSA to save significantly on their toddler’s daycare tuition by paying with pre-tax dollars.
How to Submit FSA Claims for Reimbursement
If you pay out-of-pocket for an eligible expense, you submit a claim to the FSA administrator (often a third-party company) for reimbursement. This usually involves filling out a claim form (online or paper) and attaching itemized receipts or Explanation of Benefits (EOBs) as proof of the expense and date of service. The administrator reviews the claim and reimburses you via direct deposit or check. After paying her dentist, Jane uploaded the itemized receipt and claim form to her FSA administrator’s portal for reimbursement.
FSA Debit Cards: Convenience and Pitfalls
Many FSAs come with a debit card linked to the account for direct payment at the point of service (doctor’s office, pharmacy). Convenience: Avoids paying upfront and waiting for reimbursement. Pitfalls: The IRS requires substantiation for many card swipes – you may still need to submit receipts later to prove eligibility, especially at non-standard medical merchants. Card might be declined if funds are insufficient or purchase isn’t auto-approved. Using his FSA card at the pharmacy was easy, but Bill later had to submit the receipt when prompted by the administrator.
What Happens to Your FSA if You Leave Your Job Mid-Year?
Generally, FSA funds are forfeited if you leave your job mid-year, as the account is tied to that specific employer’s plan. Any contributions stop, and you typically lose access to remaining funds unless you elect COBRA specifically for the FSA (often complex/costly) or spend the remaining balance on eligible expenses incurred before your termination date. Unspent funds revert to the employer. Leaving her job in July, Carla quickly submitted claims for expenses incurred before her last day to use her remaining FSA balance before losing it.
Estimating Your Medical Expenses for FSA Contributions (Tricky!)
This is the hardest part due to the “use it or lose it” rule. Carefully review past spending and anticipate known future costs (deductibles, copays for planned visits/prescriptions, dental work, glasses). Be conservative – it’s often better to underestimate slightly and lose a small tax benefit than overestimate significantly and forfeit hundreds of dollars. Laura reviewed her previous year’s EOBs and planned expenses to make a more accurate, conservative $800 FSA election this year, avoiding forfeiture.
Over-Contributing or Under-Contributing to Your FSA
Over-contributing risks forfeiting unused funds at year-end (“use it or lose it”). Under-contributing means you miss out on potential pre-tax savings for expenses you end up incurring anyway. Finding the right balance requires careful estimation. It’s often suggested to err on the side of slight under-contribution to minimize forfeiture risk, while still capturing tax savings on predictable costs. Realizing he under-contributed, Ken paid for unexpected dental work post-tax, missing out on savings he could have had with a higher FSA election.
Can Both Spouses Have an FSA?
Yes, if both spouses are offered a Health FSA through their separate employers, each can elect and contribute up to the individual IRS limit ($3,200 for 2024) into their own FSA. Funds from either spouse’s FSA can typically be used for eligible expenses incurred by the employee, their spouse, or their tax dependents. This allows families to potentially maximize pre-tax savings. Both Maria and her husband contributed to their respective employer-offered Health FSAs.
Using FSA Funds for Copays, Deductibles, Coinsurance
Yes, absolutely. Paying for your insurance cost-sharing amounts – deductibles, copayments, and coinsurance – for medically necessary, covered services are primary qualified expenses for Health FSA reimbursement. Using pre-tax FSA dollars to cover these common out-of-pocket costs is one of the main ways FSAs provide value and savings. Throughout the year, Sam consistently used his FSA debit card to pay copays at doctor visits and the pharmacy.
FSA-Eligible Items You Might Not Know About (Laxatives, Sunscreen)
Beyond obvious medical costs, many everyday health items qualify. Examples include: sunscreen (SPF 15+), lip balm (SPF 15+), contact lens solution, thermometers, blood pressure monitors, bandages, hot/cold packs, motion sickness aids, prenatal vitamins, reading glasses, and yes, even laxatives and other digestive aids. Always check eligibility lists (like retailer sites or FSA administrator resources) and keep receipts! Surprised, Emily learned she could use her remaining FSA funds on high-SPF sunscreen before her beach vacation.
Keeping Documentation for FSA Spending
Meticulous record-keeping is essential for FSAs. Keep all itemized receipts and Explanation of Benefits (EOBs) related to expenses paid with FSA funds or submitted for reimbursement. You’ll need these if your FSA debit card purchase requires substantiation or if the FSA administrator audits claims. Store them physically or digitally for at least the plan year, plus any relevant tax filing periods. Failing to provide a receipt when requested led to Paul having his FSA card temporarily suspended.
The Stress of the Year-End FSA Spending Spree
The “use it or lose it” rule often creates a frantic rush near the end of the plan year (or grace period) to spend down remaining FSA balances. This leads to buying potentially unnecessary amounts of eligible OTC items or scheduling last-minute dental/vision appointments just to avoid forfeiting the money. This year-end stress highlights the inflexibility of the FSA structure compared to HSAs. Every December, the office buzzed with colleagues reminding each other to “use up their FSA” before New Year’s.
Are FSAs Worth the Hassle?
For many, yes, despite the “use it or lose it” rule and record-keeping. If you have predictable out-of-pocket medical, dental, or vision expenses (copays, deductibles, glasses, etc.), using pre-tax FSA dollars provides guaranteed savings (equal to your marginal tax rate, often 20-40%). The key is accurate estimation. For those with very unpredictable or low expenses, the risk of forfeiture might outweigh the potential tax savings. Calculating her definite savings on planned braces, Jane found the FSA well worth the slight hassle.
Employer Contributions to FSAs (Less Common than HSAs)
While employers commonly contribute to employee HSAs, direct employer contributions to Health FSAs are less frequent, though possible. An employer can contribute to an employee’s FSA (up to certain limits), but it’s not a standard practice like HSA seeding often is. More commonly, the FSA benefit is simply access to the pre-tax payroll deduction mechanism. Check your specific employer’s plan documents. Unlike her previous job’s HSA contribution, Lisa’s new employer offered an FSA but made no direct contributions to it.
Changes to FSA Rules Over Time
FSA rules, particularly contribution limits and rollover/grace period options, can change based on IRS guidance and legislation. For example, the list of eligible OTC expenses has expanded in recent years, and the maximum rollover amount is indexed for inflation. Employers can also change their plan offerings (e.g., adding/removing rollover). Staying updated on current rules via your employer’s communications or IRS resources is important. Recent changes allowing OTC medications without prescriptions made FSAs more useful for many families.