What are flexible spending accounts (FSAs)?

FSAs allow pre-tax contributions for medical or dependent care expenses but typically require use of funds within the plan year.

A Flexible Spending Account (FSA) is a special type of savings account that allows employees to set aside a portion of their earnings, before taxes, to pay for eligible health-related expenses or dependent care costs. Because the money is taken out before taxes, FSAs can reduce the overall taxable income, which may lead to paying less in federal income taxes. Typically, these accounts are used for out-of-pocket healthcare expenses such as copayments, deductibles, certain medications, or medical devices. There's also a type of FSA targeted at dependent care, which can cover costs like daycare or after-school programs for children. However, FSAs usually come with a 'use-it-or-lose-it' policy, meaning the funds must be spent within the plan year, with some plans offering a short grace period or the ability to carry over a small amount of unused cash.

Imagine Sarah, who works for a large company that offers FSAs as part of its benefits package. Sarah decides to contribute $2,500 from her annual salary to her healthcare FSA. During the year, Sarah uses these funds to pay for her daughter’s braces and her own physical therapy sessions. By doing this, Sarah capitalizes on tax savings and effectively manages her family’s healthcare budget. At the end of the year, any unused funds would typically be forfeited, but since her plan allows a $500 carryover, Sarah rolls over $200 to the next year, maximizing her benefit.

If you have access to an FSA through your employer, take some time to estimate your likely out-of-pocket expenses for the year. Doing a bit of homework on past spending can help you decide how much to contribute to avoid losing any money. Keep track of expenses and deadlines to ensure you use all the funds appropriately and make the most out of your FSA benefits. Consider setting reminders for key deadlines or working with a financial advisor if managing FSAs seems daunting.