Free Guide to Understanding Flexible Spending Accounts

What Is a Flexible Spending Account and How Does It Work?

A Flexible Spending Account, commonly called an FSA, is a type of savings account offered through many employers that lets workers set aside pre-tax money for certain healthcare and dependent care costs. The basic concept is straightforward: instead of paying for these expenses with after-tax dollars, you contribute money before taxes are taken out of your paycheck, which reduces the amount of income tax you owe for the year.

Here's how the process works in practice. When you enroll in an FSA during your employer's open enrollment period, you decide how much money to contribute for the upcoming year. This amount is then divided equally across your paychecks and deducted before federal income tax is calculated. For example, if you decide to contribute $2,600 for the year and receive 26 paychecks, about $100 is taken from each paycheck and placed into your FSA account.

When you incur a qualifying expense, you can use your FSA funds to pay for it. You typically receive a debit card or reimbursement card that works like a regular payment card, or you can pay out of pocket and submit a claim for reimbursement. The money you withdraw or that reimburses you comes from your pre-tax contributions, not from your regular paycheck.

According to the Internal Revenue Service (IRS), approximately 30 million Americans participate in FSAs through their employers. The tax savings can be significant. If you contribute $2,500 to an FSA and your combined federal, state, and Social Security tax rate is about 25 percent, you save around $625 in taxes that year.

Two main types of FSAs exist: healthcare FSAs and dependent care FSAs. Healthcare FSAs cover medical, dental, vision, and prescription costs. Dependent care FSAs pay for childcare or adult care expenses while you work. Some employers offer both types, and employees can contribute to each simultaneously.

Practical Takeaway: An FSA is essentially a tax-advantaged savings tool where you use pre-tax dollars for specific expenses, reducing your overall tax burden. Understanding whether your employer offers this benefit is the first step in deciding if it makes sense for your financial situation.

Types of Expenses You Can Cover With an FSA

One of the most important aspects of understanding FSAs is knowing which expenses qualify for payment. The IRS maintains strict rules about what counts as a qualifying expense, and using FSA funds for non-qualifying expenses can result in taxes and penalties.

For healthcare FSAs, you can cover a wide range of medical expenses. Common qualifying expenses include copayments and coinsurance amounts you pay when visiting doctors or specialists. Deductibles you pay before insurance coverage begins also qualify. Prescription medications and over-the-counter medications that require a prescription are covered, though over-the-counter medications generally are not. Dental expenses including cleanings, fillings, and orthodontia qualify. Vision expenses such as eye exams, glasses, and contact lenses are covered. Mental health counseling and therapy sessions are eligible, as are hearing aids and related services.

Some expenses may surprise you. Acupuncture treatments, chiropractic care, and physical therapy are typically covered if prescribed by a doctor. Insulin and other diabetes management supplies qualify. Medical equipment like crutches, wheelchairs, and home modification equipment for accessibility is eligible. Travel costs to receive medical treatment in another city may count. Birth control pills and contraception devices are covered. Fertility treatments and related medical procedures can be included.

Dependent care FSAs cover different expenses entirely. These accounts pay for childcare services while you work, including day care centers, in-home nannies, after-school care, and summer day camps (though overnight camps do not qualify). Adult day care for an aging parent or disabled family member qualifies if you need the care so you can work. Some costs for kindergarten and pre-kindergarten programs may be covered if they include care elements beyond education.

Notably, many common health expenses do not qualify. General wellness items like vitamins and supplements typically don't count unless specifically prescribed by a doctor. Cosmetic procedures, teeth whitening for cosmetic reasons, and similar elective treatments are not covered. Gym memberships and fitness equipment don't qualify even if recommended for health reasons. Long-term care insurance premiums are not eligible. Health insurance premiums themselves generally cannot be paid with FSA funds (with limited exceptions for COBRA and certain other circumstances).

The IRS provides a Publication 502 that lists hundreds of medical expenses and whether they qualify. When in doubt about a specific expense, you can check the IRS publication or contact your FSA plan administrator for clarification.

Practical Takeaway: Spend time reviewing what your plan covers before enrolling. Make a list of recurring healthcare or childcare costs you know you'll have during the year—these are the expenses you should plan your contribution around.

Understanding the Use-It-or-Lose-It Rule and Planning Your Contribution

The most critical rule for FSA accounts is often called the "use-it-or-lose-it" provision. This rule states that any money remaining in your FSA account at the end of the plan year is forfeited—you cannot carry it over to the next year, and you don't get it back as cash. This rule exists under IRS regulations and applies to nearly all FSA plans.

How much can you contribute? For 2024, the IRS limit for healthcare FSAs is $3,300 per year. The limit for dependent care FSAs is $5,000 per year for most taxpayers (though married couples filing separately are limited to $2,500 each). These limits are adjusted annually for inflation. Your employer may set a lower limit, so check your plan documents.

Because of the use-it-or-lose-it rule, careful planning is essential. You should estimate your realistic medical and dependent care expenses for the upcoming year and contribute only what you're reasonably confident you'll spend. For healthcare FSAs, think about regular expenses: copays for routine doctor visits, prescriptions you refill monthly, dental cleanings and cleanings, vision exams, or anticipated procedures your doctor has mentioned. For dependent care FSAs, calculate what you actually spend on childcare throughout the year.

Many people make the mistake of over-contributing because they think it's "free money." It's not. If you contribute $2,500 but only spend $1,800, you lose $700—that's money from your own paycheck that disappears. According to research, the average forfeited amount across all FSA accounts is around $250 to $300 per year, suggesting many people overestimate their expenses.

However, there's an important recent change. In 2013, the IRS allowed employers to add a "rollover" provision to their FSA plans, permitting employees to carry forward up to $610 (in 2024) to the next year. Some employers also allow a "grace period"—typically 2.5 months after the year ends—during which you can continue using funds from the previous year's account. Not all employers offer these features, so check your specific plan.

Consider your life circumstances when planning. If you're expecting a child, planning major dental work, or know you need specific medical procedures, contribute more. If you're healthy, rarely see doctors, and have minimal childcare needs, contribute less. Some people calculate their expenses by month or quarter to get a more accurate picture.

Practical Takeaway: Review your last year's medical and childcare receipts and bills to calculate a realistic contribution amount. Start conservatively—it's better to under-contribute and miss some tax savings than to lose money to forfeiture. If your employer offers rollover or grace period options, use them as a safety net.

How to Enroll in an FSA and What Happens During Open Enrollment

FSAs are only offered through employers, and enrollment typically happens once a year during a designated open enrollment period. Unlike health insurance, which has multiple enrollment windows, FSA enrollment is usually limited to a specific window, often in the fall for coverage starting January 1st of the following year.

The enrollment process begins with your employer sending out plan information, usually through email or a benefits portal. This information includes details about what the plan covers, contribution limits, how to use the account, and deadlines. Many employers provide summary documents and sometimes hold information sessions to explain the plans.

To enroll, you