A flexible spending account (FSA) is a bank account that’s specifically dedicated to medical expenses. Like traditional bank accounts, it’s set up through a financial institution, and deposits are made into the account. Withdrawals can also be made from the account’s balance at any time -- but they must be used for approved medical expenses.
When an FSA is used to pay for approved medical expenses, the account provides tax benefits that other types of accounts don’t. The money deposited into an FSA is pre-tax income, meaning the account holder doesn’t have to pay taxes on that portion of their income. As long as the money is used for approved expenses, it’s also not taxed when withdrawals are made.
Sometimes FSAs are also referred to as health FSAs, because “FSA” is an acronym for other terms, such as the USDA Farm Service Agency and federal student aid.
At the time of writing, the Affordable Care Act’s limit for employee contributions made to an FSA was $2,600 in a plan year. Some plans, however, have lower limits. Because healthcare and tax laws can change every year, it’s best to ask a financial advisor what the annual limit is currently.
The list of approved medical expenses that an FSA can be used for is long. Among the many items that count as approved medical expenses are:
While there are many expenses that an FSA can be used for, there are some that aren’t approved. Some common expenses that don’t qualify include the following:
(Over-the-counter insulin qualifies even if you don’t have a prescription.)
Additionally, any approved expense doesn’t qualify if it’s being reimbursed by an insurer or another account.
Since the FSA’s purpose is to provide tax benefits, how much you can save by paying for medical expenses with an FSA depends on your tax bracket. A person in the 10 percent tax bracket will save 10 percent on any payments they make from an FSA, while someone in the highest tax bracket will save 39.6 percent.
Thus, in theory, a person who is in the 10-percent tax bracket could save up to $260 annually if they took full advantage of the maximum allowed contribution. Someone in the 39.6-percent tax bracket could save $1,029.60 (these figures assume an annual contribution limit of $2,600).
What happens to any money that’s left in an FSA when the plan year ends depends on the FSA. In some cases, the funds are forfeited and no longer available. In other cases, plan holders can roll over up to $500 to next year’s plan.
The easiest way to open a flexible spending account is to talk with a financial advisor. They can explain all of the intricacies of these accounts, help you determine how much to deposit in one, and set it up for you.