What is an FSA?

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Flexible Spending Accounts (FSAs) can be a great addition to your current health insurance plans, allowing you to offer a comprehensive benefits package without spending a fortune. But we get it, the thought of researching a new plan can feel daunting.

What is it? How does it work? Will my employees get use out of it?

In this guide to FSAs, we answer all of those questions and more. So whether you’re an employer who may want to offer an FSA, you’re an employee interested in this benefit, or maybe you have an FSA and need a little help understanding how best to use it, this guide will walk you through the necessary information.

An FSA is an account offered by an employer, to which employees can contribute pre-tax dollars from their paycheck in order to pay for medical care, supplies and other services. Employers can also contribute money to employees’ FSAs but aren’t required to do so.

Annual maximum contribution limits vary for each type of FSA, as do the rules for employer contributions, and how and what you can spend the contributions on. There are different types of FSAs and each type can only be used for a specific purpose. The three we cover in this guide are:

Healthcare FSAs
Dependent Care FSAs
Limited Purpose FSAs

Healthcare or General Purpose FSAs

Employers can offer Healthcare FSAs to help employees pay for eligible medical, dental and vision expenses their insurance plans don’t cover. Unlike HSAs, FSAs don’t need to be paired with a specific health insurance plan, which is good news as employees have more freedom to choose the health plan that works for them. But like HSAs, there are particulars to FSAs that employers and employees alike must be aware of.

Characteristics of a Healthcare FSA

Eligibility. Someone is only eligible to open and contribute to an FSA if their employer offers one.
Contribution limits. Whether they’re an individual or a member of a family of four, an employee’s contributions cannot exceed $3,500 in 2027 ($3,400 in 2026). This may not seem like a lot given how expensive medical care can be, but unused funds beyond the plan’s carryover or grace period allowance are forfeited at the end of the plan year, so it’s wise to encourage employees to budget only for what they think they’ll need.
Rollovers, etc. Employers have the option of allowing employees to roll over up to $680 of unused 2026 funds into 2027, and up to $700 of unused 2027 funds into 2028, or they can provide a 2.5 month grace period during which employees can spend their remaining contributions. But they can’t offer both.
Can employees change the amount they contribute? Employees must choose their annual contribution amount at the beginning of the plan year and then the employer deducts the appropriate amount each month. Employees can only change their election if there is a change in their employment or the “family status” that is specific to their health plan.
Can employees also have an HSA? To enroll in a Healthcare FSA, you must stop contributing to your HSA. You can still use your existing HSA funds to pay for qualified medical expenses, but since unused FSA funds beyond any carryover or grace period are forfeited at the end of the plan year, it makes sense to spend your FSA dollars first. If you want to keep contributing to your HSA, a Limited Purpose FSA or a Dependent Care FSA can be used alongside it.
Can employers contribute to a Healthcare FSA? Yes, employer can contribute to a Healthcare FSA, but are not required to do so. Their contributions do not count to the annual Healthcare FSA contribution limit. Regardless of the amount employees contribute, employers may contribute up to $500. After $500, they must match employee contributions dollar for dollar.

What can Healthcare FSAs be used for?

Some qualified medical expenses for Healthcare FSAs include:

Copays
Some prescriptions
Deductibles
Over-the-counter drugs and medicines, with no prescription required
Medical supplies and equipment like crutches and bandages
Diagnostic devices like blood sugar kits

Contributions to a Healthcare FSA can be used to cover:

Employees
Employees' spouses
Employees' dependents, including children under the age of 27

There are some things FSAs cannot be used for:

FSA contributions cannot be used for:

Insurance premiums
Long-term care coverage
Any expenses covered under another health plan

Important Healthcare FSA tax information:

Contributions into an FSA (from both employee and employer) are NOT subject to federal or state income taxes, nor are they subject to the employee portion of payroll taxes. For a Healthcare FSA to maintain its tax-qualified status, the company must follow IRS rules for cafeteria plans and highly compensated and key employees. If more than 25% of the plan's nontaxable benefits go to key employees, those employees must include their FSA benefits in their taxable income. For 2026, a key employee is:

An officer with annual pay of more than $235,000.
A 5% owner of the business.
Anyone who owns 1% or more of the business AND has annual pay of more than $150,000.

The upside? You don't need to fill out any special tax forms if you have a Healthcare FSA.

Dependent Care FSA

A Dependent Care FSA is a pre-tax account offered by employers to help employees save and pay for child and dependent care. It's meant to help employees pay for services that allow them to work when they would otherwise need to be at home, fulfilling caretaking duties.

One of the major benefits of this FSA? You can contribute to this type of FSA and a health savings account (HSA) at the same time with no penalties.

Unlike Healthcare FSAs, Dependent Care FSAs are not front-loaded. This means that you fund the account throughout the year with each deduction from your paycheck, and you can use the money once it’s deposited into the account.

How to be eligible for a Dependent Care FSA

The eligibility rules for a Dependent Care FSA are somewhat complex:

Like all FSAs, someone can only open and contribute to a Dependent Care FSA if their employers offer it as a benefit.
To open a Dependent Care FSA, you must have at least one of the following living with you full time: a child who is under the age of 13 or a spouse or relative who is physically or mentally incapable of taking care of themselves.
If the employee and their spouse are divorced, only the spouse with primary custody may contribute to this type of FSA.
If the employee is married, both spouses must work and earn income unless one spouse is disabled and unable to work.
If employees don't follow these rules, the money they and the company contribute to their FSA will be forfeited and they will have to pay income taxes on the forfeited amount.

Dependent Care FSA contribution limits

In 2026 and 2027, employees may contribute up to $7,500 if they file taxes as an individual, or are married filing jointly. They may contribute up to $3,750 if they're married but file taxes separately (each spouse can contribute $3,750 to separate FSAs). Employers may contribute to a DCFSA, but those contributions count towards the contribution limit.

Changing Contribution Amount
Employees participating in the Dependent Care FSA must choose their allocation at the beginning of the calendar year and can only change their allocation within 31 days of a qualifying event (e.g. birth of a child, adoption, death of a dependent, divorce, change of employment, etc.)

Qualified expenses for a Dependent Care FSA

Acceptable Dependent Care FSA expenses include:

Physical care
In-home care, such as an au pair, nanny, or babysitter
Care in an institutional setting like child or adult daycare given by qualified caregivers
Transportation provided by caregivers
Application fees, deposit, etc. required for obtaining care (but only if care subsequently provided)

You can't use a Dependent Care FSA for all care:

A Dependent Care FSA is a great asset to have if you have kids or other dependents, but it can't be used for ALL care. Here are a few things it CANNOT be used for:

Babysitting that is provided by a sibling or child under the age of 19, or another individual who can be claimed as a dependent
Education, such as private school or tutoring
Overnight camps
Enrichment activities like sports or music lessons
Custodial nursing care or long-term care for parents not living with employees taking the FSA benefit
Housekeeping

The benefits of a Dependent Care FSA

Not only do they lower employees’ tax burdens, they could enable employers to keep good employees in their workforce. The high cost of childcare and care for parents and other dependents could lead employees to think it’s not worth the cost to keep working. But if they could pay for this care with pre-tax dollars (or even with a contribution from their employer), they might feel more incentivized to stay in the workforce.

Important Tax Information: If employees do contribute to a Dependent Care FSA, they will need to complete and submit IRS Form 2441 when they file their taxes.

Limited Purpose FSA

Contributions to Limited Purpose FSAs can only be used for dental and vision expenses that employees’ health plans don’t cover. The rules for these accounts are similar (but not exactly the same) as the Healthcare FSAs.

How to be eligible for a Limited Purpose FSA

The only way that someone is eligible for a Limited Purpose FSA is if their employer offers it as a benefit to their employees.

Limited Purpose FSA contribution limits

The 2027 contribution limit for a Limited Purpose FSA is $3,500. It was $3,400 in 2026.

Similar to Healthcare FSAs, employers have the option to allow employees to roll over up to $680 of unused 2026 funds into 2027 and up to $700 of unused 2027 funds into 2028, or they can provide a 2.5 month grace period during which employees can spend their remaining contributions. They cannot offer both.

Changing contribution amount

Employees must choose their annual contribution amount at the beginning of the plan year and then the employer deducts the appropriate amount from their paycheck pre-tax every month. Employees can only change their election if they have a qualifying life event.

Qualified expenses for a Limited Purpose FSA:

Qualified dental and vision expenses for Limited Purpose FSAs include:

Eye glasses, contacts, and solution
Braille books and magazines
Copays
Deductibles
Office visits
Diagnostic services
Non-cosmetic surgery for dental care and reconstruction
Dentures and bridges
Eye exams
Drug treatments (both prescription and over-the-counter)
Guide dogs (dog, training, care)
Eye surgery (including laser and LASIK)
Orthodontia
Guards for teeth grinding
X-rays
Transportation expenses to receive care

What you CANNOT use your Limited Purpose FSA for:

FSA distributions cannot be used for the following expenses:

Health insurance premiums
Long-term care coverage or expenses
Anything covered under another health plan

How do FSAs work?

FSAs are funded through employer transfers that they deduct from their employee's monthly paychecks. The process goes like this:

Employer front loads the funds for employee FSAs.
The employer then deducts the contribution amount that the employee elects from the employee's paycheck.
Those funds are then held in the company's bank account to use.

How are FSA funds distributed?

There are two main ways that FSA funds are distributed:

Debit cards: If the employer has set up the FSA with a debit card, employees have direct access to their funds and can pay for expenses at the point-of-sale. Some card purchases still require a receipt to substantiate the expense.

Reimbursements: If the employer hasn’t given employees direct access to their funds, employees will need to pay for their expenses first, then submit the proper documentation to the FSA administrator for reimbursement. Reimbursements can come in the form of direct deposits to employees’ bank accounts or checks mailed to their address.

Frequently Asked FSA Questions

How much can I contribute to a Healthcare or General Purpose, Limited Purpose, or Dependent Care FSA?

For 2027, the IRS limit is $3,500 for a Healthcare or General Purpose FSA and for a Limited Purpose FSA, up from $3,400 in 2026. The Dependent Care FSA limit is $7,500 per household for both 2026 and 2027, or $3,750 if married filing separately. Employers can set a lower limit. Spouses who each have a Healthcare FSA can both contribute up to the limit.

What can I use my FSA funds for?

Employees can use FSA funds to pay for any medical related expenses like copays, deductibles and other out-of-pocket costs. Search Lively's updated list of FSA eligible expenses. Unlike a Health Savings Account, the full FSA fund amount is available for use on the first day of the plan year, rather than accumulating throughout the year.

How is my FSA funded?

FSAs are funded through payroll deductions. The full amount of our FSA is available immediately at the employees plan start date. The employer then deducts the contribution amount that the employee elects from the employee's paycheck.

What does it mean to substantiate an expense?

FSAs require that every expense is approved by the plan sponsor (typically your employer). This is because your employer is putting in place a plan that walks through all eligible expenses that the plan is allowed to pay for.

If you (as the employee) are utilizing pre-tax FSA funds on expenses that are not approved by the IRS, your employer could face penalties and fines by the IRS for non-compliance. As a result, if they can’t, with confidence, know that you spent your funds on qualified medical expenses, they will ask you for further documentation or proof so that the use of those funds were “substantiated”. This is what gives them the protection they need in case of an IRS audit.

Is an FSA tax-free?

Yes, employees elect how much to contribute into the account at the beginning of each plan year. Then, the total annual amount is deducted from the employees’ paycheck equally throughout the year. Any employer contributions are also tax-free.

Who can enroll in an FSA?

Most full-time employees are eligible to enroll in their employer’s FSA. An employee does not need to enroll in the employer’s healthcare to be eligible to enroll in their FSA. An FSA is not a healthcare plan but can be used in conjunction with a healthcare plan in the US.

Do my FSA funds roll over at the end of the year?

FSA funds roll over at the end of the year only if your employer’s plan offers a carryover, and any unused funds above the carryover limit are forfeited. For plans with a carryover, you can roll over up to $680 of unused 2026 funds into 2027, and up to $700 of unused 2027 funds into 2028. Carried-over funds don’t count toward the next year’s contribution limit. Instead of a carryover, some plans offer a grace period, which gives you up to 2.5 extra months to spend remaining funds. A plan can offer a carryover or a grace period, but not both. Your plan may also include a run-out period, which is extra time to submit claims for expenses from the prior plan year.

What happens to my FSA if I leave my job?

Once an employee leaves a job, any unused FSA funds will be returned to the employer. However, employees will have 90 days to submit any outstanding FSA eligible expenses.

What are Medical (Healthcare) FSA, Limited-Purpose FSA and Dependent Care FSA?

Medical (aka Healthcare) FSAs help employees pay for eligible medical, dental and vision expenses their insurance plans don’t cover. Unlike HSAs, FSAs don’t need to be paired with a specific health insurance plan, which is good news as employees have more freedom to choose the health plan that works for them.

Limited-Purpose FSAs can only be used for dental and vision expenses that employees’ health plans don’t cover. The rules for these accounts are similar (but not exactly the same) as the Healthcare FSAs. One of the major benefits of this FSA? You can contribute to a Limited-Purpose FSA and a health savings account (HSA) at the same time with no penalties.

A Dependent Care FSA is offered by employers to help employees save and pay for child and dependent care. It's meant to help employees pay for services that allow them to work when they would otherwise need to be at home fulfilling caretaking duties.

How is an FSA different from an HSA?

An FSA and an HSA both pay for qualified medical expenses with pre-tax dollars, but they differ in ownership, rollover, and eligibility. An FSA is tied to your employer. You choose your contribution once per plan year, and unused funds are forfeited beyond any carryover or grace period your plan allows. An HSA belongs to you. Funds roll over every year, stay with you if you change jobs, and can be invested. HSAs have higher contribution limits but require an HSA-eligible health plan, while an FSA works with most health plans.

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.

FSA Guide