3 Key Types of Flexible Spending Accounts (FSA)

Employers can sponsor Flexible Spending Accounts so employees can use pre-tax funds to pay for certain expenses no covered under health insurance. There are different types of FSAs that cover different types of purchases, and we discuss those here.

A Flexible Spending Account (FSA), is an employer-sponsored savings account into which you can contribute pre-tax money to pay for out-of-pocket expenses not covered under your insurance plans. That means you could end up saving up to 30% on those costs, depending on your tax burden. While the IRS limits the amount you can contribute to each type of FSA, if your employer decides to contribute to your account, that money doesn’t count toward your annual limit.

Sounds pretty great, right? It is, as long as you’re mindful of the fact that you can’t keep your contributions indefinitely. Instead, you must use the money in your account by the end of the plan year or else forfeit anything that remains. The good news is: your employer has the option to allow either a 2 ½ month grace period during which you can use the rest of your money, or a maximum rollover of a small amount of funds (set annually by the IRS) into the following year. The downside is that they can’t offer both. If you elect to roll over funds, they won’t affect your contribution limit for that following year.

How Do I Use My FSA

During open enrollment, you elect the amount you’d like to save for the year and then your employer takes the appropriate amount from each paycheck to fund your FSA. As we said above, your employer can also contribute to your account, but it’s not required to do so.

Choosing the correct amount to save each year is an important decision. There’s some wiggle room if you’ve saved too much and your employer offers the rollover or grace period, but what happens if you realize you’re not saving enough? Unfortunately, you cannot change your elected contribution amount outside of open enrollment unless a “qualifying event” happens in your life. Qualifying events are defined differently for each type of FSA but generally speaking, they include a change in marital status, birth of a child, or some other event that causes you or a dependent to qualify for coverage under that FSA.

When you want to use your FSA money, most administrators require you to pay for the out-of-pocket expense first, then submit documentation (i.e. a receipt or other proof of purchase) in order to get reimbursed. Some, like dependent care FSAs, allow you to set up a direct payment with the care provider.

There are many niche types of FSAs but the three key accounts are: Healthcare FSAs, Dependent Care FSAs and Limited Purpose FSAs.

Healthcare FSAs

Healthcare FSAs are set up to help employees pay for out-of-pocket medical expenses with pre-tax money. Eligible expenses include (but are not limited to): deductibles, copays, prescriptions, over-the-counter drugs for which you have a prescription (insulin refills don't need a prescription), out-of-pocket dental and vision care, crutches, blood sugar test kits and bandages.

The contribution limit for healthcare FSAs is set each year by the IRS and you can use this money to pay for medical expenses for you, your spouse and any dependents which you claim on your tax return. If both you and your spouse have an FSA, you can each contribute up to the maximum in your respective accounts.

What you can’t do is double-dip. If one spouse reimburses a medical expense through their FSA, the other spouse can’t reimburse for the same expense.

To change the annual amount you contribute outside of open enrollment, you must have either had a change in marital status or the birth of a child. Otherwise, you’ll have to wait until the following year’s open enrollment to change your selection.

Dependent Care FSAs

Dependent Care FSAs were set up to help working parents and caregivers pay for the care that allows them to work. That means: a nanny, babysitter, daycare, preschool, summer day camp, and before and after school care for children under the age of 13; and adult daycare for a spouse, parent, or other relative who is physically or mentally disabled. These expenses must either enable you to work or look for work. That means volunteering doesn’t count, nor does the babysitter you need for date night.

Another rule you should be aware of is: the dependents for which you are paying for care must live with you at least the majority of the time. If you and your spouse are divorced, only the parent who is the primary caregiver can contribute to a Dependent Care FSA.

The annual limit for this type of FSA is $5,000 for a married couple filing jointly, or $2,500 for each individual FSA if you each have a separate account. If you want to change the amount you’ve elected to save, one of the following must apply:

  • You’ve had a change in marital status.
  • You’ve had a change in the number of dependents.
  • The cost of care has changed.
  • You or your spouse has had a change in employment status.
  • Something happened to cause one of your dependents to either become eligible (e.g. an older child or parent who becomes disabled) or cease to be eligible (e.g. a child turns 14).
  • You’ve had a change in residence.

Limited Purpose FSAs

Limited Purpose FSAs are the only type of FSAs you can contribute to while also contributing to an HSA. This is because these FSAs can only be used to pay for out-of-pocket dental and vision expenses. If your employer offers both, it’s a good idea to take advantage of each because using your Limited Purpose FSA for dental and vision expenses allows you to reserve more money in your HSA for retirement.

But since you can pay for dental and vision expenses with both your HSA and Limited Purpose FSA, it’s important to note, you can’t double-dip by submitting the same expense for reimbursement from both accounts. You have to pick one.

The contribution limit for Limited Purpose FSAs is set by the IRS each year, and you can use this money to pay for you, your spouse and your dependents.

As the cost of health and dependent care continues to rise, and as more and more of the financial burden is placed on the employee, FSAs are an important tool in the arsenal of employer benefits. They help you save money and lessen the stress of paying for these inevitable expenses. This means you have more time and mental energy to focus on work, your family and simply enjoying your life.

Disclaimer: the content presented in this article are for informational purposes only, and is not, and must not be considered tax, investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, including fund prospectuses, and consult with appropriate tax, investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.

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