Flexible spending accounts, or FSAs, are special savings accounts offered through some employer benefit plans. They allow the account holder to pay for certain out-of-pocket medical and dependent care costs with tax-free money.
However, FSAs come with some rules and regulations. For instance, FSA rules cap the amount of money that can be placed in the account each year ($3,050 for 2023), and also dictate which types of expenses qualify for an FSA distribution.
Still, FSAs can be a powerful tool for covering unavoidable medical costs that could otherwise wreak havoc on finances.
Flexible Spending Account Explained
FSAs are savings programs offered through employers — which means that self-employed people aren’t eligible. Those who are self-employed may be covered through an employed spouse’s plan, or they may choose to open an HSA, if they qualify.
FSAs are also sometimes called flexible spending arrangements, and they can cover you, your spouse, and your dependents. There are also a few sub-types of FSAs, such as dependent care FSAs (DCFSAs) and limited purpose FSAs (LPFSAs).
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Flexible Spending Account Rules: An Overview
FSA contributions work similarly to employer-sponsored retirement plans like 401(k)s: a certain amount of wages is withheld each pay period and contributed to the account.
The account holder elects how much to withhold at the beginning of the plan year — and, importantly, they may not be able to change it unless there’s a change in employment or family status. That means it’s important to think the decision through carefully.
But unlike a 401(k), the funds placed into an FSA aren’t just tax-deferred — they’re actually tax-free. That means they aren’t included in the account holder’s total taxable income, nor are taxes due when distributions are made.
How Much Can I Contribute to My FSA?
In 2023, account holders may contribute up to a maximum of $3,050 per year to their FSAs. Employers may also place limits on the amount an employee can elect to be contributed, up to this federal cap.
Unused Funds: FSA Rollover and Reimbursement Rules
Another rule regarding FSAs is the fact that, generally speaking, unused FSA funds are forfeited.
In other words, FSAs are “use it or lose it” accounts; the money that isn’t used for qualified expenses by the end of the plan year can’t be rolled over into the next.
Thus, account holders may want to be cautious to avoid over-contributing to the plan and carefully estimate how much they think they’ll need to spend on out-of-pocket health expenses. Setting up a budget may help with this.
However, there are some exceptions that may be accessible, depending on the employer’s policy choice. They may allow for a “grace period” or a carry-over option — one or the other, but not both, and they’re not legally required to offer either.
• The grace period option allows account holders to use their FSA funds for an additional two and a half months after the plan year to pay for qualified medical expenses.
• The carry-over option allows account holders to roll over up to $610 of unused funds into the account for use the next plan year, though the employer may specify a lower dollar figure. Carryover doesn’t affect the maximum allowable contribution for the next year’s plan.
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What Can a Flexible Spending Account Be Used For?
Given the contribution limits and forfeiture rules of flexible spending accounts, FSA account holders usually want to be careful about calculating how much money they might be able to use — otherwise, significant amounts of their paycheck might end up right back in their employers’ hands.
And although many medical expenses qualify, not all of them do, or especially rules apply. For instance, non-prescription medications are covered only with a doctor’s prescription. The exception is insulin, which is covered without a prescription.
FSA funds are also ineligible to be used for health insurance premiums (though you can use them for deductibles and copays) or long-term care coverage and expenses, which may affect those with chronic illnesses or disabilities.
There are, however, a wide range of procedures and healthcare services that FSA funds can be used to cover, including dental expenses.
In basic terms, any treatment that would qualify for a medical expense tax deduction can be covered by FSA funds; the full list of which can be found in IRS Publication 502 .
From acupuncture and alcoholism to birth control pills and psychological counseling, many services do count as qualified medical expenses.
Along with being the right kind of medical expense, services paid through FSA funds must be applied to the right people in order to be covered. Eligible beneficiaries include:
• The account holder
• Their spouse
• Dependents claimed on their tax return
• Children age 26 and under
Keep in mind, too, that FSAs generally work in conjunction with other types of health benefits and coverage, and funds can’t be used to reimburse services that are covered under other health plans.
It might be a valuable exercise to write out all of the expected medical expenses you’ll face as a family at the beginning of the plan year in order to decide how much to contribute, including additional coverages, in order to avoid over-contribution. While nobody can predict the future, some routine expenses can be foreseen — and a little bit of planning might save a lot of forfeited funds in the end.
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Taking Distributions from an FSA
The process for taking distributions from an FSA may vary based on the plan. In some cases, distributions are made from an FSA to reimburse the account holder for medical expenses they’ve incurred. Some FSAs also have a debit, credit, or stored value card that can be used to pay directly for qualifying expenses.
In order to take a distribution, the account holder may have to provide a written statement from the doctor or medical service provider that specifies the medical expense incurred, as well as a statement documenting that the expense hasn’t been covered by any other health plan. In other situations, a receipt may be sufficient documentation in order to be reimbursed.
FSA reimbursements are only available for verifiable medical expenses that have already been incurred, rather than expenses the account holder plans to incur in the future. (In other words, you can’t write to the FSA and tell them you’re going to the doctor next month.)
Finally — and importantly — FSA participants must be able to use the entire benefit (that is, the total amount of money they pledged to contribute to the plan) even if those monies haven’t yet been contributed. There is some opportunity for roll-over, depending on the plan rules. Some FSAs allow account holders to carry over up to $610.
For example, if you decide to contribute $2,000, but get hurt midway through the year when only $1,000 has been deducted from your pay, you’ll still be able to use up to $2,000 worth of tax-free FSA coverage for qualified expenses. Pretty cool, huh?
Is a Flexible Spending Account Worth It?
A flexible spending account can be a helpful tool, but it’s not the only option for footing medical bills.
For one thing, $3,050 might not even scratch the surface of some common medical procedures, such as childbirth.
Furthermore, although the tax-free nature of FSAs is attractive, the prospect of forfeiting parts of a paycheck is definitely not — and there are other ways to save cash for medical expenses and other emergencies which offer not just flexibility, but growth.
For example, you could open an online bank account with a high-yield and earn more than 4% APY (annual percentage yield) in interest. That could be an option to explore.
Another idea is to create an emergency fund to help pay medical expenses. However, if you think you’ll use all the funds in an FSA, going that route instead may be worth more to you.
The tax benefits of the FSA can make them an appealing and useful tool, especially for those who know they’ll spend a decent amount out of pocket on healthcare.
But if you’re not sure you’ll use the funds saved in an FSA, a SoFi Checking and Savings account could be an alternative solution. You’ll earn a competitive APY and you’ll pay no account fees. You could even use a SoFi Checking and Savings account as a complementary tool, along with your FSA, to work toward other saving goals.
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