Understanding Flexible Spending Accounts (FSAs): Key Points to Know
A Flexible Spending Account (FSA) is a tax-advantaged financial tool offered by employers to help employees pay for certain out-of-pocket medical, dental, and dependent care expenses. FSAs are becoming increasingly popular as they offer significant tax savings and can help individuals manage health-related costs. Whether you’re already knowledgeable about FSAs or just learning about them, knowing the ins and outs of how they function, their advantages, and limitations can allow you to get the most out of this wonderful benefit.
In this blog, we’re going to explain key points to help you gain a better understanding of FSAs and assess if they’re the best fit for your financial situation.
1. What is a Flexible Spending Account (FSA)?
An FSA is a pre-tax savings account that enables employees to contribute a portion of their income to cover eligible out-of-pocket costs. The funds you contribute to an FSA are taken out of your paycheck before taxes are deducted, which reduces your taxable income for the year. FSAs are generally provided as part of an employee benefits package and can be used to cover a variety of healthcare and dependent care expenses.
There are two typical kinds of FSAs:
- Health Care FSA: For medical, dental, and vision expenses not reimbursed by insurance.
- Dependent Care FSA: For child care or care for dependents while you’re working.
2. Key Features of FSAs
a. Tax Advantages
One of the greatest advantages of an FSA is tax savings. Since the money you put in is taken out of your paycheck before taxes, you lower your taxable income, which can decrease your total tax liability. For instance, if you put $2,000 into an FSA, you will only pay taxes on $2,000 less of your entire income, saving you hundreds of dollars in taxes.
b. Employer Contributions
Some employers will match or contribute to your FSA. Although this is not always true, employer contributions can add even more value to having an FSA. Make sure to inquire with your employer to determine if they provide this benefit.
c. “Use It or Lose It” Rule
FSAs are governed by the “use it or lose it” rule, so the money you put in must typically be spent by the end of the plan year, or it will be lost. But some employers provide a brief grace period (usually 2.5 months after the end of the plan year) to spend any leftover money. Or, the IRS provides for a carryover option for employers, where employees can carry over some unused funds (up to $570 in 2025) into the following year.
3. Qualified Expenses
a. Health Care FSA
Health care FSAs can be applied towards a broad range of medical costs, such as:
- Doctor’s office co-pays
- Prescription drugs
- Dental treatment (e.g., cleanings, fillings, braces)
- Vision treatment (e.g., eyeglasses, contact lenses)
- Over-the-counter drugs (with a prescription from a doctor)
- Medical supplies (e.g., bandages, thermometers)
b. Dependent Care FSA
A Dependent Care FSA may be used to pay for care of children under age 13, and dependent adults who are physically or mentally unable to care for themselves. Qualified expenses include:
- Child care services (e.g., daycare, nursery school)
- After-school care programs
- Summer day camps
- Care for a dependent adult (e.g., adult day care)
- Keep in mind, though, that there are contribution limits to what you can put into a Dependent Care FSA—$5,000 for single people or joint filers, and $2,500 if married filing separately.
4. Contribution Limits
The IRS establishes yearly contribution limits on FSAs. For 2025:
- Health Care FSA: You may contribute up to $3,050 per year.
- Dependent Care FSA: You can contribute up to $5,000 for individuals and joint filers or $2,500 for married filing separately.
These are subject to adjustment every year due to inflation and IRS rules. Make sure you refer to the limits of the current year before making a contribution to your FSA.
5. How FSAs Work
After you choose to contribute to an FSA through your company, you determine how much money you wish to contribute annually. This money is taken out of your paycheck in small, frequent payments over the course of the year. You can then use the money to cover qualified expenses as they occur.
To get your money, you usually have an FSA debit card, using which you can pay straight out for qualified expenses, or you can reimburse yourself via receipt submission. Automatic reimbursements and claim submission by hand are also possible in some plans through an online platform.
6. Advantages of Using an FSA
a. Direct Access to Money
For Health Care FSAs, although your contributions are taken from your paycheck during the year, you have access to the entire balance of your FSA at the beginning of the year. This allows you to utilize your FSA funds to pay for expenses in advance, without having to wait until you have made the entire contribution.
b. Saving Money on Medical Expenses
Most medical, dental, and vision bills are not paid in full by insurance. FSAs enable you to save on these costs by spending pre-tax dollars. You also save more in taxes on what you contribute by spending pre-tax money, cutting down your overall medical bills.
c. Reduced Taxable Income
Because contributions to your FSA are taken out of your pay before taxes, you owe less in federal income taxes, Social Security taxes, and Medicare taxes. This tax savings can be substantial over time, allowing you to lower your taxable income and boost your take-home pay.
7. Considerations and Limitations
a. “Use It or Lose It”
As noted above, FSAs also have a “use it or lose it” policy. If you fail to utilize your money within the end of the plan year (or the grace period, if any), you risk losing any accrued balance. Avoid this by carefully projecting your expenses and attempting to not over-contribute.
b. Limited Flexibility for Non-Eligible Expenses
FSAs may only be applied for eligible expenses set forth by the IRS and your company’s plan. You risk facing penalties and taxation if you utilize your FSA funds on non-eligible goods.
c. No FSA for Side Jobs
If you work for more than one employer (e.g., full-time and part-time), you can’t contribute to more than one FSA. You can use the contribution limit across all your jobs, so planning is essential.
8. How to Maximize Your FSA Benefits
To get the most out of your FSA, follow these tips:
- Estimate Your Annual Expenses: Carefully predict how much you’ll spend on medical and dependent care expenses. This can help prevent over-contribution, which leads to forfeiting funds.
- Spend the Money Wisely: Spend your FSA on recurring medical expenses such as doctor appointments, dental exams, and prescription drugs. If you have a high medical expense, use your FSA to pay for it immediately, instead of letting it accumulate over the course of many years.
- Log Your Expenses: Monitor your qualifying expenses during the year so that you don’t let your FSA money lapse before you’ve used it.
9. Conclusion
Flexible Spending Accounts are a very useful tool for saving on dependent care and medical care expenses while lowering your tax liability. You can boost your take-home pay and save money on medical expenses by using pre-tax dollars to cover eligible expenses. But careful planning, estimates of your expenses, and adherence to the “use it or lose it” provision are needed. With careful planning and coordination, an FSA can be a worthwhile supplement to your financial plan.