An FSA is a flexible spending account or a flexible spending arrangement. An FSA is a benefit offered by an employer that allows employees to put their pre-taxed income aside to pay for medical and dependent care costs.
The benefit of using money from your FSA rather than your checkbook to pay for approved expenses is that the money in an FSA is the gross amount you earn without taxes deducted. This amount will never be subject to income taxes, reducing your total tax bill.
It can also be an excellent way to spread out your payments through regular contributions, so when you have a significant expense, it’s easier to manage.
How Does a Flexible Spending Account (FSA) Work?
Flexible spending accounts are set up through your employer to provide you with a tax break for some approved medical and dependent care expenses. When one encounters these expenses, one can use this money to pay them, pay a portion of the expense, or reimburse you for payments you’ve already made.
How FSAs Work
FSAs are accounts where you put aside money earmarked to go to specific qualifying expenses. This money comes directly from your pay before you’re taxed, saving you money in the long run and creating a fund to help cover expected and unexpected expenses.
FSAs have two main categories, one that covers health-related expenses and one that covers dependent care. Health expenses include glasses, over-the-counter medications, menstrual supplies, etc. These items are necessary but not part of your traditional health insurance coverage.
Dependent care FSA covers your child’s preschool, daycare, babysitting, and other expenses related to their care. Dependent care is not limited to children. If you care for elderly parents, they may also qualify.
Using FSA Funds
If enrolled in an FSA, you regularly deposit some of your pre-tax income into the account. When you incur a qualifying expense, you can pay for it with your FSA money in a few ways. You could withdraw the money from your account, you might receive an FSA debit card, or your plan will reimburse you for expenses you’ve already paid.
2022 FSA Limits
The FSA limit for 2022 is $2,850 for individuals and $5000 for married couples. That amount is the maximum an individual can put into an FSA in 2022. Most flexible spending accounts run during the calendar year with a use-it-or-lose-it approach. If your employer does allow a rollover, then the maximum you can carry over is $570 of unused funds.
Also, suppose your employer offers a matching FSA contribution. In that case, their contribution amount is above and beyond the amount you put aside, but there are limits on how much they can contribute. An employer may put aside $500 for all employees, whether they’re contributing to their FSA or not. After that $500, the employer can only match on a dollar-for-dollar basis.
Note that you do not need to put aside $2,850 a year if you don’t think you’ll need that much. If you’re more comfortable putting $1,000 into your FSA, you can speak to your company’s human resources department and make sure that’s all you’re saving. You can also change the amount annually during your enrollment period.
Advantages of a Flexible Spending Account (FSA)
An FSA can be a significant benefit, especially if your employer contributes to your account. Employer contributions boost your income and help you pay for health and dependent expenses you’re going to incur anyway.
Reduced Payroll Taxes
One of the most significant benefits of an FSA is that your employer deducts the money pre-tax. Rather than paying taxes on the money you earn and then only getting the remaining amount or bills, you get the total amount.
Reduced Taxable Income
Working off the pre-tax benefit, the amount that comes off the top of your gross income and goes into your FSA does not count as part of your total income. If you make $30,000 a year and contribute the entire $2,850 allowed to your FSA, taxes only apply to the remaining $27,150 income.
Getting reimbursement from your insurance company can take a very long time. Because your FSA doesn’t have the obstacles, reimbursement is faster. It depends on how your specific plan works, but some plans give you a debit card that you can use immediately to pay for your expenses without waiting for reimbursement.
Disadvantages of a Flexible Spending Account (FSA)
Getting to use your money without paying income taxes is a considerable benefit. Reducing your tax bill is also very desirable. Therefore, an FSA might seem like an easy choice. However, to perform due diligence, consider the following:
Risk of Fund Forfeiting
Probably the biggest downfall of an FSA is that you risk forfeiting the money you put aside if you don’t use it in the allotted timeframe. If you’re young, healthy, and have no dependents, you might not incur any qualifying expenses, then that money is lost. It’s also possible to forget about using your FSA for everyday items like tampons, aspirins, and or products like sunscreen.
FSAs Can Be Confusing
Another downfall of FSAs is that they’re not the same across the board, which means each employer can have a different setup. To fully enjoy your FSA, it’s essential to understand your policy.
Who Should Consider a Flexible Spending Account (FSA)?
If your employer offers a matching contribution to your FSA, you should consider opting into this program. They’re giving you free money to help you pay for some necessities you’re going to need anyway. But, of course, this will require you to dip into your FSA when purchasing these items or save receipts for reimbursement.
People with dependents are also great candidates for FSAs because they’ll be spending money on childcare or adult dependent care anyway.
If you’re on top of your budget and know how much you’ll spend each year on health and dependent expenses, then you can efficiently use your FSA and not worry about forfeiting any of it. It takes a little budgeting and record-keeping, but it can add significant financial benefits.