Flexible Spending Account (FSA)

What Is an FSA?

A flexible spending account (FSA) is an employer-sponsored benefit employees use to pay for approved health and dependent care costs. Organizations can offer FSAs along with an insurance plan, enabling employees to set aside money for qualifying expenses outside the scope of their policy. FSAs also reduce your employees' taxable income and your organization's payroll taxes, providing mutual advantages.

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Types of FSA Accounts

Each flexible spending arrangement has specific rules employers and employees must follow and a structure that appeals to different needs. Depending on your company's benefit program, you may offer one or more of the following FSA accounts:

How Does a Flexible Spending Account Work?

Employees sign up for an FSA during open enrollment. 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:

FSA vs. HSA: What's the Difference?

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 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).

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Flexible Spending Account Rules to Know

The IRS sets the guidelines for each FSA 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:

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 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 2023 health FSA and LPFSA limits are $3,050 for contributions and $610 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 2022, the DCFSA contribution limit is $2,500 (married filing separately) or $5,000 (single or couples filing jointly). Employees are eligible to participate in this plan if they have a dependant who is:

IRS Publication 503, Child and Dependent Care Expenses, provides more information about DCFSA rules.

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

Dependent Care FSA-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:

Online FSA Stores

Many retailers have dedicated online sections for FSA-eligible items, 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 run 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.

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