Summary: A flexible spending account (FSA) allows employees to contribute a portion of their regular earnings to pay for health-related costs.
A flexible spending account (FSA) is an employee benefit that allows employees to set aside money to pay for healthcare and dependent care. Here we delve into advantages of FSAs and how they work.
Flexible Spending Account (FSA)
A flexible savings account or arrangement (FSA) is a specific type of account used to save for medical expenses in the US. This is essentially a way for a household to save money specifically for the medical expenses it expects to incur over the course of a year. Contributions by employees are made tax-free and employers can also contribute. As long as these expenses are disbursed for qualified medical expenses for the employees and their spouses or dependents, they are never taxed.
The purpose of an FSA is to allow working people to save money specifically for medical expenses like medicine, check-ups, and dental care. An FSA lets employees save money tax-free because their contributions are deducted from their gross income through voluntary salary reduction programs. Plans like these help reduce the burden of health care costs both on employees and their families and through claims with insurance companies. They also avoid taxing medical expenses.
How FSAs Work
FSAs are linked to inflation by the IRS, so that contribution limits are not the same each year. During the open registration period, employers offering FSAs to their employees can sign them up using voluntary salary reduction agreements. In these agreements, employees agree to have part of their salary deducted, usually each pay period. Since these amounts are deducted from their gross salary, they’re not taxed. Employers can also contribute to these plans, and their contributions will also be set.
In 2024, the limit on salary reduction contributions for the year is $3,200. Spouses that both have FSAs can both reach this cap and contribute $6,400 for their households. There are generally no limits on employer contributions except for plans that cover highly compensated employees.
The funds in an FSA can be used to reimburse qualified medical expenses. These expenses include medications (prescription and over-the-counter), medical and dental expenses, eye exams, checkups, and visits to specialists that may not be covered by insurance. They can’t be used to reimburse insurance premiums, long-term care expenses, or costs already covered by other health insurance. Disbursements can be made to reimburse the policyholder, their spouse, and their dependents, including their children under the age of 27 at the end of the tax year. When disbursements are made, they’re also not taxed.
FSAs are known as use-it-or-lose-it plans because the funds added to them are typically forfeited if not used within the year. However, plans can include grace periods of up to two-and-a-half months after the end of the year to use the remaining funds. The IRS also allows a fraction of the funds to be rolled over and used in the next year. The rolled-over amount does not affect the contribution limit for the year. For 2024, the rollover allowance is $640.
Advantages of FSAs
Flexible spending arrangements have many advantages for both employees and employers. These include:
- Tax benefits for employees: Any contributions made by employees into their FSAs are deducted from their gross salaries and are therefore not eligible for income, Social Security, or Medicare taxes. The amounts contributed by their employers are also not counted toward their gross income.
- Pay in advance: With a registered FSA, contributions are promised throughout the year. Therefore, the total annual contribution to the FSA can be used to reimburse medical expenses even before these funds are deducted from the employee’s salary and put into the FSA. This gives employees advance access to their funds if they have medical expenses early on in the year.
- Cost savings for employers: If employers make FSA contributions, they can pay less to their employees in salary. Since their contributions can be written off as expenses, this can help employers save money.
- Attracting talent: Employers are not required to provide FSAs for their employees. Doing so, however, can produce a benefit that may help make their compensation packages more attractive to potential hires.
Best Practices for Managing FSAs
Employees should think carefully about their annual medical expenses before entering FSA plans. Because most of these funds will be forfeited if not used during the year, it’s important for employees to accurately estimate their expenses for the year. They should calculate medication costs, average numbers of checkups, and other regular expenses. They should also be clear on the types of expenses that can and cannot be reimbursed. It’s also important to note that employees need written statements from independent third parties stating the amounts of medical expenses incurred. They also need to make a written statement that the se expenses have not been reimbursed by any other health insurer.
Flexible Spending Arrangements for Tax-Free Health Savings
FSAs allow employees to save their own money tax-free for their annual medical expenses. Their contributions and those of their employers do not contribute to their taxable income making FSAs tax-favorable savings vehicles.
FAQ
If you contribute to an FSA, the amounts you contribute are not subject to personal income tax or Social Security tax. If you contribute and receive disbursements for qualified medical expenses, these disbursements are also not taxed. However, you cannot claim these amounts on your personal income tax return as an itemized deduction on Schedule A (Form 1040).
Contributions to your FSA should be made based on the qualified medical expenses you expect to use throughout the year. They can still be used after the end of the year, however, for up to 2.5 months if your plan states a grace period. An amount of up to $640 can also be rolled over from 2024 to 2025 as long as this is stated in your plan. Any other funds in excess of this amount will be forfeited.
Authors:
Marcel is an experienced journalist and Public Relations expert with an honours degree in Journalism and bylines with a range of major brands.