What Is a Flexible Spending Account? | FSA Definition

HealthCare Writer

Updated on March 4th, 2021

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A flexible spending account (FSA), also known as a flexible spending arrangement, is an account set up by employers that allow employees to contribute pre-tax dollars from their earnings to pay healthcare costs, including cost-sharing copays and coinsurance as well as some medicines.

Another type of FSA, called a dependent-care FSA, helps employees pay for dependent care, such as childcare costs while parents are working. For this article we will focus only on healthcare FSAs.

What You Need to Know:

The money you contribute to an FSA has to be spent on qualified medical expenses during a specified period, usually the calendar year, or your balance is forfeited back to your employer.

 It’s important to carefully estimate what you’ll spend on qualified health expenses to determine how much you should contribute to an FSA in any given year.

Some employers provide an extended period to spend FSA funds or allow employees to roll over up to $550 from one plan year to the next. Employers may also contribute up to $500 upfront and then match worker contributions dollar for dollar to $2,750. 

How Does an FSA Work?

If your employer offers an FSA, you may contribute a set amount — up to $2,750 in 20201 — for qualified medical expenses if you don’t have health insurance or for expenses not covered by your health insurance plan. Worker contributions are usually deducted directly from their paycheck. Also, some employers offer FSA debit cards to make accounting easier.

You can start using FSA dollars for healthcare expenses before you have fully funded your account. But, if you do not spend your full balance for qualified healthcare reimbursements during a specified period, your employer may keep your balance. In effect, that’s a pay cut.2

To avoid losing money, it’s important to know exactly how your employer’s plan works and the cutoff date for spending your FSA dollars. Most plans follow the calendar year, which means you must spend the money on qualified health expenses by December 31. Many employers offer a grace period that extends the deadline up to two and a half months — into March of the following year. Still others allow you to carry over $550 of your contributions into the next plan year.3

Did You Know?

An employer can contribute up to $500 to an employee’s FSA and match contributions dollar for dollar from $501 to the annual limit of $2,750.

Employers can offer one of these advantages but not both. And no employer is required to offer either one. However, employers can also contribute up to $500 to an employee’s FSA (even if that person doesn’t make any contributions of their own), and starting at $501, they can make a dollar-for-dollar match to an employee’s contribution. Besides, employer contributions to an FSA do not cap the amount that an employee is allowed to contribute. For example, your employer may only contribute $500, but you can still contribute up to $2,750. 

Note: In light of the coronavirus pandemic the IRS has loosened rules for FSAs for the calendar year 2020, allowing employees to enroll, increase or decrease contributions or stop contributions throughout the year. Previously, workers had to designate their contribution at the beginning of the year and could only make changes at midyear if they had a significant qualifying event, such as marriage, divorce, or a child’s birth.

What Are the Pros of an FSA?

Using pre-tax dollars to pay for health expenses can save you money. You save the amount you would have paid in income taxes on every dollar you spend for qualified health costs.

You can use FSA money to pay for a wide range of healthcare expenses that the IRS has deemed qualified, including everything from unreimbursed surgery expenses to more everyday items like contact lens solution and ace bandages. (See more on qualified healthcare expenses below.)

You can start to spend your balance for qualified expenses the day the FSA goes into effect. Employers usually front the money, then wait for your contributions. For example, let’s say that you have a tooth implant in January that isn’t covered by your dental insurance. You are allowed to use the full amount of your anticipated FSA contributions for the year to help pay for it.

What Are the Cons of an FSA?

Because the employer owns the account, you can’t take the money you’ve contributed with you if you change jobs.

And, as discussed above, the so-called use-it-or-lose-it rule is a major downside to contributing to an FSA during uncertain times. You may end up losing money you contributed.

Did You Know?

Thanks to the CARES Act, you can spend your FSA money on over-the-counter drugs like aspirin and allergy medicines without a prescription from your doctor.

What Can You Buy with an FSA? 

FSA contributions can be used for you, your spouse or your dependents on dental, vision and medical expenses that are not covered by any health insurance you may have. You can also pay for deductibles, copayments and coinsurance with an FSA. However, you’re not allowed to pay insurance premiums with FSA money.4

The list of IRS-approved, qualified expenses also includes medical equipment, such as diagnostic devices, crutches and even bandages, as well as health necessities, such as lip balm and thermometers.

You can spend FSA money on prescription medicines not covered by your insurance and copays for covered prescription drugs. The CARES (Coronavirus Aid, Relief, and Economic Security) Act passed in March 2020 allows FSA money to be used for over-the-counter drugs without a doctor’s prescription and menstrual care products.5 

For a complete list of qualified expenses for your FSA, check with your employee benefits department.

Next Steps

Employees who plan carefully and keep an eye on their FSA spending deadline soon discover a flexible spending account can be a great way to save money on unreimbursed healthcare costs. 

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  1. Internal Revenue Service. “Eligible employees can use tax-free dollars for medical expenses.” irs.gov (accessed October 5, 2020).

  2. The U.S. government website for the Health Insurance Marketplace. “Using a Flexible Spending Account (FSA).” healthcare.gov (accessed October 5, 2020).

  3. Using a Flexible Spending Account (FSA).”

  4. Using a Flexible Spending Account (FSA).”

  5. Internal Revenue Service. “IRS outlines changes to health care spending under CARES Act.” irs.gov (accessed October 16, 2020).