What is an FSA? Everything You Need To Know About Flexible Savings Accounts

Is your team taking full advantage of their hard-earned perks?

When it comes to flexible spending accounts, they might not be. According to a recent survey, 91% of businesses offer Flexible Spending Accounts (FSAs) to all or some of their employees. However, the Employee Benefits Research Institute (EBRI) found that almost half of FSA holders forfeited funds to their employers. So, how do you make sure your employees get the most our of this benefit?

While an FSA is great for paying for health-related products and services, this account falls under the use-it-or-lose-it category. Being strategic about saving and spending is the key to tapping into this perk’s potential. But if your employees aren't maximizing their flex spending plan, there might be a disconnect between how much they truly understand about it and the ways it helps them save each year.

Employee benefits packages speak to your company’s values, attract up-and-coming talent, and foster a healthier, happier workforce. However, an FSA may not feel like much of a reward if your employees think this benefit is costing them more than they’re saving in the long run.

In this guide, we’ll explore what an FSA is, how it works, and some smart ways employees can cash in their funds.

What is an FSA?

An FSA, or in its full form, a Flexible Spending Account, is a tax-advantaged, employer-sponsored health benefit. Also called a Flexible Spending Arrangement, an FSA can be used to pay for certain out-of-pocket healthcare expenses. A portion of each employee’s paycheck contributes towards their FSA pre-tax, and (though not required) employers may add matching contributions. FSAs also reduce your employees' taxable income and your organization's payroll taxes, providing mutual advantages.

A healthcare FSA covers a variety of needs, making it a highly versatile health benefit to offer. It’s used to pay for medical and dental copayments, prescription and over-the-counter drugs, and even medical equipment and first aid supplies. Employees who have an HC FCA can:

• Save as much as 30% on eligible expenses
• Carry up to $680 over from one year to the next when re-enrolling
• Access the full amount if required from day one of the FSAFEDS plan year.

Employees may get a debit/credit card to pay for qualified purchases or use their own money and submit a receipt for reimbursement. And, because employees reduce their taxable income by contributing to their FSA, your business pays less in FICA taxes each year.

How does a Flexible Spending Account work?

FSA guidelines require employees to sign up for an account during an annual open enrollment period. It's generally not required for an employee to enroll in a group health plan to open an account, but you can offer an FSA as an additional wellness perk. Here's an overview of how the process works:

• Contributions: Employees contribute through pre-tax payroll deductions. The employer may also match contributions, much like a 401(k).
• Access: The account receives a lump sum at the beginning of the plan year. This means participants don't have to wait for the account to accrue before using it on larger expenses.
• Payment: Employees use an FSA card to pay directly or submit receipts for reimbursement after paying out of pocket.
• Ownership: An FSA is an employer-owned benefit, so an employee can't take it with them if they leave the company.

Types of FSA accounts

Each Flexible Spending Account has specific rules that employers and employees must follow and structures that appeal to different needs. Depending on your company's benefit program, you may offer one or more of the following FSA accounts:

• Healthcare FSA: This FSA is for any IRS-approved medical expense.
• Dependent Care FSA (DCFSA): This dependent care benefit is only for costs related to your employees' qualifying dependents (child or adult).
• Limited-Purpose FSA (LPFSA): An LPFSA is exclusively for dental and vision expenses not covered by an insurance plan.

FSA rules and guidelines to know

The IRS sets the FSA guidelines for each program, but employers may also incorporate select provisions to craft a cafeteria plan that appeals to their workforce. Key FSA rules to know include:

Remaining FSA funds

FSAs fall under the use-it-or-lose-it category, so unused funds expire at the end of each plan year. However, employers may include either a carryover provision or a grace period in their programs.

• FSA carryover: A certain amount of the previous year's balance can roll into the next year's savings.
• FSA grace period: Employees receive an additional 2.5 months to use up their balance.

Any remaining funds in the account after the deadline go directly back to the company. An employer may use these funds for limited purposes, such as offsetting plan administrative costs.

FSA limits

The IRS sets contribution and carryover limits and regularly adjusts them for inflation. This is the most an employee and employer can contribute to the account collectively each year, and the most an employee can roll over into the next plan year (should the plan allow). The 2025 health FSA and LPFSA limits are $3,300 for contributions and $660 for carryovers.

Dependent care FSA rules

A DCFSA, or Dependent Care Assistance Plan (DCAP), works a little differently than other FSAs. Generally, your employee pays for qualified expenses out of pocket and requests reimbursement later. As of January 1, 2026, the DCFSA contribution limit increases to $3,750 (married couples filing separately) and $7,500 (single people or couples filing jointly), respectively. Employees are eligible to participate in this plan if they have a dependent who is:

• A child under age 13 at the time of service
• A spouse unable to care for themselves physically or mentally who lived with the employee for more than half the year
• Another qualified person unable to care for themselves physically or mentally who lived with the employee for more than half the year

For more information about DCFSA rules, read the IRS Publication 503, Child and Dependent Care Expenses report.

FSA eligibility

Most employees who work for a company that offers FSAs will be eligible for one. However, you may not be eligible if you already have an HSA, as these are used to pay for medical expenses of the same type.

However, some companies may offer specialty FSAs, such as a Dependent Care FSA (DC-FSA) or a Limited Purpose FSA (LP-FSA)—these can often be used in conjunction with an HSA. You don’t generally need to be enrolled in a health insurance plan to be eligible for an FSA, although you may want to be due to Health Care Reform.

FSA-eligible expenses

Employees can use their health FSA and LPFSA on qualified medical expenses tax-free. These typically exclude insurance premiums, long-term care coverage, and amounts covered under another health plan.

However, many everyday health products and services are FSA-eligible, such as:

• Copays and hospital bills
• Prescription drugs
• Over the counter (OTC) medications
• Eyeglasses, contact lenses and eye examinations
• Laser eye surgery
• Radial keratotomy
• Orthodontia and other dental work
• Maternity care supplies
• Menstrual care products
• Birth control
• First aid supplies
• Mobility equipment
• Addiction treatment
• Hearing aids
• Immunizations
• Nursing services
• Ambulance services
• Diagnostic device services
• Medical testing devices
• Chiropractic care
• Acupuncture
• Body scans
• Blood pressure monitors
• Cholesterol testing kits
• Bandages and Band-aids
• Healthcare office visits
• Laboratory fees

DCFSA-eligible expenses

A DCFSA applies to things that support a qualifying person's wellbeing and protection, allowing your employees and their spouses to work or seek employment. Examples of eligible dependent care FSA purchases include:

• Nursery school or preschool expenses
• Before- and after-care programs
• After-school programs
• Adult daycare expenses
• Babysitting services

Online FSA stores

Many retailers have dedicated online guidance on what is classed as an FSA-eligible item, including Target, Walmart, and CVS. This makes it easier for employees to find the everyday products they need and, most importantly, maximize their FSA before it expires.

Managing FSA and HSA programs

FSAs and HSAs both involve employees setting aside funds from their paychecks for similar reasons, but these accounts operate very differently. If your organization offers one or both of these tax-advantaged benefits, create a plan to educate your employees about their options and clarify which program(s) you offer during open enrollment.

What is an FSA?: FAQs

Hopefully, you now have a clear understanding of what an FSA is and how it works. In case you have more questions, we’ve provided answers to some of the more commonly asked questions.

What's the difference between an FSA and an HSA?

A Health Savings Account (HSA) is another tax-advantaged plan that lets employees save money for medical costs. However, HSAs are  only  for employees enrolled in a high-deductible health plan (HDHP). These funds are allowed to grow in the account year over year and can be invested in stocks, bonds, and other securities.

Can you have an FSA  and  an HSA?

The LPFSA and DCFSA are usually compatible with an HSA plan. For instance, an LPFSA can supplement out-of-pocket costs if the employee's HDHP only covers certain types of care (e.g. health and vision only or health and dental only).

What are the downsides of an FSA?

While an FSA can offer several benefits that make it financially easier to manage healthcare, there are some downsides. It’s always worth evaluating your healthcare costs to make the most of this tax-free savings option and avoid losing money.

• Restrictions on eligibility: FSA guidelines mean only certain qualifying expenses for medical expenses, vision and dental treatments, and dependent care can be claimed for
• Use-it-or-lose-it: Unless your employer has a carryover or grace period option, any funds you don’t use each year will be lost
• Limited accessibility: Most employees can only access an FSA during enrollment, or following a qualifying major life event such as having a baby or getting married
• IRS caps: The IRS sets a limit on how much you can contribute and set aside each year
• It’s not for everyone: If your medical expenses are minimal or unpredictable, you may find unused funds going to waste each year.