What a Flexible Spending Account (FSA) Actually Does

A Flexible Spending Account lets you set aside pre-tax money for medical and dependent care costs

A Flexible Spending Account (FSA) is an employer-sponsored plan that lets you put money into an account before taxes are taken out of your paycheck. You then use that money to pay for medical expenses or dependent care costs that your health insurance does not cover, or to cover the out-of-pocket portions of care that it does. Because the money goes in before taxes, you pay less in federal income tax and payroll taxes on the money you contribute.

FSAs come in two types: a Medical FSA for health care costs, and a Dependent Care FSA for child care or adult dependent care. Some employers offer both; some offer only one. You choose which accounts to use and how much to contribute each year during your employer's open enrollment period, usually in the fall.

The trade-off is that FSA money must be used by the end of the plan year or you lose it. There is no rollover to the next year, with a narrow exception: some plans let you carry over up to $610 (as of 2024, though this amount can change) into the next year. This "use it or lose it" rule means you need to estimate your costs carefully before you commit money to the account.

Key Takeaways

• FSA contributions come out of your paycheck before federal income tax and payroll taxes, which reduces your taxable income and the total tax you owe.
• Medical FSAs cover deductibles, copays, coinsurance, and some expenses insurance does not cover, but the IRS maintains a specific list of what counts.
• Dependent Care FSAs pay for child care, preschool, or care for an adult dependent while you work, up to an annual limit set by the IRS.
• Money left in your FSA at the end of the plan year is forfeited unless your plan includes a carryover option, so you must estimate your costs before enrolling.
• You access FSA money through a debit card, reimbursement request, or direct payment to providers, depending on what your employer's plan allows.

How a Medical FSA works and what it covers

When you enroll in a Medical FSA, you choose an annual contribution amount and that money is divided across your paychecks throughout the year. Your employer deducts it before calculating your federal income tax, Social Security tax, and Medicare tax. At the end of each pay period, the money sits in your FSA account, ready to use.

Medical FSAs cover a long list of out-of-pocket health care costs. This includes insurance deductibles, copays, and coinsurance. It also covers expenses your insurance does not cover at all, such as dental work, vision care, hearing aids, and some over-the-counter medications and medical supplies. The IRS publishes a detailed list of what qualifies; common items include pain relievers, allergy medicine, bandages, crutches, and glucose monitors. Cosmetic procedures and general wellness items like vitamins do not count unless they treat a specific medical condition.

You cannot use a Medical FSA for health insurance premiums, long-term care insurance, or expenses covered by a spouse's plan. If you have a high-deductible health plan paired with a Health Savings Account (HSA), you cannot contribute to a Medical FSA in the same year — the IRS does not allow both.

How a Dependent Care FSA works and what it covers

A Dependent Care FSA works the same way as a Medical FSA in terms of how money flows into the account, but it covers a different set of expenses. This account pays for child care, preschool, after-school programs, and summer camps while you work. It also covers care for an adult dependent — such as an aging parent or disabled spouse — if that care allows you to work.

The IRS sets an annual contribution limit for Dependent Care FSAs. For 2024, the limit is $5,000 per household per year (this limit can change annually). If you are married and file taxes jointly, you and your spouse share this $5,000 limit combined, not each. The care provider must be someone other than a spouse or a dependent you claim on your taxes, and you must have earned income to contribute.

Dependent Care FSAs do not cover tuition for kindergarten or higher grades, overnight camps, or care that happens when you are not working. They also do not cover the cost of a nanny or babysitter if that person is your dependent or spouse.

The tax savings you get from an FSA

The main benefit of an FSA is the tax savings. Because FSA contributions come out before taxes, you reduce your taxable income. If you contribute $2,500 to a Medical FSA and you are in the 22% federal tax bracket, you save roughly $550 in federal income tax alone. You also avoid paying Social Security tax (6.2%) and Medicare tax (1.45%) on that money, which adds another $195 in savings. Over a year, those savings add up.

The exact amount you save depends on your tax bracket and your state's income tax rate. Someone in a higher tax bracket saves more; someone in a lower bracket saves less. Self-employed people and those without employer-sponsored plans cannot open an FSA — this benefit is only available through an employer.

The "use it or lose it" rule and how to avoid losing money

The biggest risk with an FSA is the forfeiture rule. Any money left in your account at the end of the plan year is gone — you cannot roll it over to the next year or take it as a refund. This is why FSAs require careful planning. If you contribute $2,500 and only spend $1,800, you lose $700.

Some employers offer a grace period or a carryover option to soften this rule. A grace period gives you an extra 2.5 months after the plan year ends to spend down your balance. A carryover lets you roll up to $610 (as of 2024) into the next year. Your employer chooses whether to offer either option, so check your plan documents to see what applies to you.

To avoid forfeiture, estimate your actual costs for the coming year and contribute only what you are confident you will spend. If you have a Medical FSA, think about routine copays, your deductible, and any planned procedures. If you have a Dependent Care FSA, calculate your actual child care costs for the year. It is better to contribute less and miss out on some tax savings than to contribute too much and lose money.

How to access your FSA money

Your employer determines how you access FSA funds. Most Medical FSAs come with a debit card that you can swipe at pharmacies, doctors' offices, and other health care providers. Some plans require you to pay out of pocket and then submit a reimbursement request with receipts. A few plans let you authorize direct payment to providers.

Dependent Care FSAs typically work through reimbursement. You pay the care provider yourself and then submit an invoice or receipt to your FSA plan administrator for reimbursement. Some employers partner with dependent care providers that accept FSA debit cards directly, but this is less common than with Medical FSAs.

Keep all receipts and documentation. Your FSA plan administrator may ask for proof that an expense qualifies, especially for items that are not obviously medical. If you cannot provide documentation, you may have to repay the reimbursement out of pocket.

FSA vs. HSA: when to choose each one

If your employer offers both an FSA and a Health Savings Account (HSA), you need to understand the difference because you cannot have both in the same year. An HSA is only available if you are enrolled in a high-deductible health plan. An FSA is available regardless of what health plan you have.

An HSA lets you roll money over year to year with no forfeiture, and you can invest the balance. An FSA requires you to spend the money each year or lose it. However, an HSA has a lower annual contribution limit than an FSA for individuals, and you must have a high-deductible plan to use one. If you have a traditional health plan with a lower deductible, an FSA may be your only option.

The choice depends on your health plan type and how confident you are in predicting your costs. If you have a high-deductible plan and expect significant medical expenses, an HSA is usually better because you keep unused money. If you have a traditional plan or expect to spend most of what you contribute, an FSA works well.

Frequently Asked Questions

What happens to my FSA money if I leave my job?

You lose access to your FSA when you leave your employer. Any money remaining in the account is forfeited. However, you may be able to continue coverage through COBRA, which extends your FSA for a limited time, though you must pay the full premium yourself. Check with your employer's benefits office about COBRA may be able to access before you leave.

Can I change my FSA contribution amount during the year?

No, not normally. FSA elections are locked in for the plan year and you cannot change them. The only exceptions are may have access to life events, such as marriage, divorce, birth of a child, or loss of other health coverage. You must request a change within 30 to 60 days of the event, depending on your plan.

Do I need receipts to use my FSA debit card?

It depends on your plan. Some FSA debit cards work like regular debit cards with no receipt required. Others require you to submit a receipt within a certain time frame to prove the expense was medical or dependent care related. Check your plan documents or call your FSA administrator to understand your plan's rules.

Can I use my Medical FSA for my spouse or children?

Yes. Your Medical FSA can pay for out-of-pocket costs for you, your spouse, and any dependent you claim on your taxes, regardless of whether they are on your health insurance plan. The money does not have to be used only for your own care.

What if I overestimate my costs and have money left over?

If your plan does not offer a grace period or carryover, that money is forfeited. If your plan offers a carryover, you can roll up to $610 into the next year. If it offers a grace period, you have an extra 2.5 months after the plan year ends to spend the balance. Review your plan documents to see which option applies to you.