A flexible spending account, or FSA, allows eligible employees to set aside pre-tax money to use throughout the year on qualified expenses. The funds can be used for deductibles, medication, copays, and other medical expenses.
Since the contributions are tax-free, the employer also saves on payroll taxes. The small administrative fee the employer must pay per month per participating employee is much less than payroll taxes.
Moreover, the employer owns the account, so any unused money by the end of the year or (the grace period) is returned.
Employees also save money by contributing to an FSA and reducing their taxable income. In 2022, participating employees can contribute up to $2,850, as determined by the Internal Revenue Services (IRS).
Common Features of FSAs
- Annual contribution limit of $2,850.
- No eligibility requirements.
- Tax-free contributions.
- Most plans come with a debit card.
- Employer-owned account.
- Account not portable with a job change.
- Preloaded funds available at the beginning of the plan year.
FSA plans are usually used for medical expenses that are not covered by other health plans. The account is also preloaded at the beginning of the plan year, and the funds are immediately available for use.
Employees can spend the money right away on a wide range of qualifiable expenses, some of which include:
- Dentist cleaning.
- Dermatologist exams.
- Medical massages.
- New glasses.
- Blood pressure monitors.
- Hearing aids.
- Smoking cessation programs.
- Prenatal vitamins.
How to Set Up an FSA
Employers can add this benefit at a low cost.
Setting up and managing an FSA is relatively simple. Working with a third-party administrator will make the process trouble-free and help gain more insight into flexible spending accounts.
Third-party administrators handle all the documentation mandated by the Internal Revenue Services (IRS), saving the employer valuable time and money. The employer decides on the contributing amount if it does not exceed the limit set by the IRS. They can also choose whether to offer the grace period and carryover option to their employees.
Flexible spending accounts are known for the “use it or lose it” rule.
This means that any unused money on the account by the end of the year is forfeited. Employers can choose to offer two exceptions to this rule, a grace period and a carryover option.
These exceptions increase employee participation because there is less worry about not using funds fully.
Employees are given 2½ months to use the previous year’s funds for new expenses. After the grace period is over, all unused money is forfeited.
With the carryover option, an employee can carry over up to $500 of the unused funds to the following year. The amount is available for the entirety of next year’s plan. This allows for wasteful spending of the funds just to avoid losing them.
What is the Difference Between a Health Savings Account & a Flexible Spending Account?
The eligibility requirements set the health savings account (HSA) apart from the flexible spending account (FSA).
Employees can only participate in an HSA if they have a qualified high deductible health plan (HDHP) and meet other qualifications.
Unlike HSA, there are no eligibility requirements for FSA. As a result, it’s more commonly offered by employers. Employees do not have to have health insurance to be enrolled in an FSA.
HSA funds roll over, and the contribution limit is higher. Hence, employees use it as a long-term savings plan for major health expenses. Since FSA funds cannot be rolled over, it is recommended to be used as a short-term savings plan for predictable health expenses every year.
Administrative Services and Flexible Spending Accounts
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Types of FSA
Employees and employers are most familiar with the health care FSA. However, there are other flexible spending accounts that employees can have access to. Employees can participate in multiple FSAs; it should be noted that the funds cannot be transferred from one account to another.
1) Health Care FSA (Full Purpose)
Often referred to as full purpose FSA. It covers the participants, as well as their spouse and other eligible dependents. Participants have access to medical, dental, prescription, and vision care. Participants cannot be enrolled in both FSA and HSA.
2) Dependent FSA
Participants can apply to use it for childcare and elder care, before and after school care, summer day camp, nursery school, and pre-school. Medical and health care expenses are not covered with this account. It covers all eligible dependents.
Although we previously mentioned that participants cannot be enrolled in FSA and HAS simultaneously, there is a special limited-purpose FSA. If an employee has an HDHP with a HAS, they can be eligible for a limited purpose FSA. This means that participants only have access to dental and vision care.
Flexible spending accounts have become a recognized benefit used by many employers to help recruit and retain employees.
It is a win-win benefit, where employers save on payroll taxes and employees pay fewer taxes on their income.