What is a 'Flexible Spending Account (FSA)'

A flexible spending account (FSA) is a type of savings account available in the United States that provides the account holder with specific tax advantages. Set up by an employer for an employee, the account allows employees to contribute a portion of their regular earnings to pay for qualified expenses, such as medical expenses or dependent care expenses.

BREAKING DOWN 'Flexible Spending Account (FSA)'

One of the key benefits of a flexible spending account is that the funds contributed to the account are deducted from the employee's earnings before they are made subject to payroll taxes. As such, regular contributions to an FSA can significantly lower an employee's annual tax liabilities.

Constraints of Flexible Spending Accounts

There are limits to how much can be contributed to an FSA account per year. For medical expense FSA accounts, the limit is set by the employer. Each FSA is limited to $2,600 per year per employer. If an individual is married, they may put up to that same limit of $2,600 in an FSA through their employer as well. The funds from an FSA can be used towards payment of certain authorized dental and medical expenses, including for dependents and spouses.

These funds may also be used to cover deductibles and co-payments when medical services are rendered. However, the money may not be used to pay for insurance premiums.

Prescription medications, over-the-counter drugs that have been prescribed by a doctor can be paid for through money from an FSA. This include receiving reimbursements for insulin. Medical equipment purchases, such as diagnostic devices, bandages, and crutches can be covered by FSAs.

All the money set aside in an FSA generally must be used by the end of the plan year, however employers can offer a grave period of up to two-and-a-half months to use that funding. If that option is not taken, employers might let workers carryover $500 per year of unused funds from their accounts. Such options do not have to be offered by an employer. If they are, the employer can only offer one of these options.

When the year ends or the grace period expires, any funds that remain in the FSA are lost. This compels FSA holders to try to carefully plan out the amount of money that will go into the account and how they will spend it over the course of the year.

The size of the federal tax savings that an FSA offers may vary. For a person who saves some 30 percent on their federal taxes, if they earn $50,000 in salary and put $2,000 into an FSA, they could save about $600.

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