Editor’s note: An earlier, and shorter version of this blog post was previously published. We published this update because the rules aren’t complicated, but knowing them will prevent you from incurring penalties or losing your Flexible Spending Account contribution.
Flexible Spending Accounts (FSAs) are an excellent way to help you save for anticipated medical, dental, and vision expenses. As well as dependent care costs.
Like all tax-advantaged accounts, the IRS has rules and regulations on how FSAs function. Especially about who can contribute and how much. And what those contributions can be used for. As you’ll see, the Flexible Spending Account rules aren’t complicated. But you will need to follow them to avoid incurring a penalty or losing any of your contributions.
What is a Flexible Spending Account (FSA)?
Let’s start with the basics. A Flexible Spending Account (FSA) is a spending account. It allows you to contribute tax-free money to pay for eligible medical, dental, vision, or dependent care expenses. Depending on the type of account you have.
The three most common types of FSAs are the Healthcare FSA for medical expenses. A Limited Purpose FSA is for dental and vision expenses. And the Dependent Care FSA is for expenses associated with child and adult day care.
Where Do I Sign up for an FSA?
FSAs are employer-based plans. Typically you set up an FSA when you begin a job or during the yearly open enrollment period. The only other time would be after a qualifying event like a marriage, birth, or death of a dependent, among others. Unfortunately, those who are self-employed aren’t eligible for an FSA.
How Do I Contribute to an FSA?
When you elect to participate in your employer’s FSA, you can choose how much you want to contribute for the year up to the applicable IRS annual contribution limit. Then, your employer will deduct the appropriate amount from each paycheck and deposit that money in your FSA. Your employer can also choose to contribute to your FSA, but they aren't required to.
Each type of FSA has its own contribution limit. For 2021 the limits are as follows:
Healthcare FSAs: $2,750. Healthcare FSA contributions work on an individual basis. So each spouse in the household can open their own FSA if it's offered by their employer. And each spouse can contribute up to the 2020 contribution limit. That’s a maximum of $5,500 per married couple.
Limited Purpose FSAs: $2,750. Limited Purpose FSAs also work on an individual basis. As such, both spouses must open their own accounts through their respective employers. A married couple can contribute a maximum of $5,500.
Dependent Care FSAs: $5,000. Dependent Care FSAs function differently. Contribution limits are determined by household and tax filing status. If you are a married couple who files jointly, you may open one Dependent Care FSA and contribute up to $5,000 into that account.
If you file separately from your spouse, you may open two separate accounts. Provided you’re both given the option through your employers. And contribute up to $2,500 in each account. If you and the other parent of your child(ren) are divorced or separated, only the parent with primary custody of the children may open and contribute to a Dependent Care FSA.
The IRS typically ties contribution limits to inflation and as such, they are subject to change annually.
What Can I Use My FSA For?
A Healthcare FSA is set up to help you use pre-tax dollars to pay for medical expenses. For you, your spouse, and your dependents.
Qualified medical expenses include but are not limited to:
- Prescriptions and over the counter drugs
- Transportation costs (to and from medical appointments)
- Emergency care
- Medical supplies like crutches, bandages, first aid kits, and more
- And more from the FSA Store
A Limited Purpose FSA allows you to use your contributions to pay for dental and vision costs. For you, your spouse, and your dependents.
These expenses include but are not limited to:
- Vision exams
- Dental exams
- Teeth cleaning
- Treatment for cavities, crowns, root canals, and more
- Contact lenses
A Dependent Care FSA helps you pay for any type of dependent care that allows you to work. Or look for paying work. No volunteering allowed.
Here are a few examples:
- Daycare and after school care for children under age 13
- In-home assistance, medical care, or nursing home care for a disabled or ill spouse. And in-home care, nursing home, or childcare for disabled or severely ill children of any age
- In-home caretaking, medical care, or senior home care for a disabled or ill parent
- Summer day camps and programs (no overnight camps)
- Adoption assistance
Can I Contribute to Another Tax-Advantaged Account in Addition to This One?
No. And yes. If you have an active Health Savings Account (HSA), you will have to stop contributing to that account before taking advantage of your employer’s Healthcare FSA.
There's good news though. You can still use previous HSA contributions while you’re actively contributing to a limited purpose or dependent care FSA. You just can't add any contributions while using a Healthcare FSA. Or, you can save your already contributed HSA funds for the future and use your Healthcare FSA contributions for more immediate expenses.
You can, however, contribute to an active HSA and have an active Limited Purpose FSA or Dependent Care FSA. Because these two account types are not healthcare-related there isn’t a conflict. Remember, you can’t contribute to an HSA and have an active Healthcare FSA. But you can have an HSA and Limited Purpose FSA or Dependent Care FSA.
You Must Use It, or You’ll Lose It
One thing to keep in mind with FSAs is that they are a “use it or lose it” option. That means funds can only be used during the calendar year they are contributed. If you have money left in your account at the end of your plan year, you lose what remains.
Employers have the option to offer employees one of two solutions for left-over contributions. But are not required to do so. They can either offer an FSA rollover option where you can roll up to $500 from your 2019 account into your 2020 account. This increases to $550 from 2020 into 2021. Or they can offer a 2.5 month grace period that allows you to spend your FSA money for up to 2.5 months after the plan year ends. That’s usually March 15.
If you decide to participate in your employer’s plan, you’ll want to take some time to map out your future expenses. This way, you'll be sure to contribute the right amount.
Does your employer offer an FSA? And is the option to use pre-tax money to pay for medical, dental, vision, or dependent care expenses attractive to you? Ask about the details of your employer’s plan. The pretax nature of these accounts can lead to significant savings. And it’s always nice to know you have money socked away for when you need it.
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.