Banking 101: Using a Flexible Spending Account (FSA) for Medical Expenses

A flexible savings account (FSAs) is a savings account dedicated for select medical costs. You fund the account with pretax contributions from your paycheck, and you can use the money for eligible expenses. Your health insurance plan does not cover all your medical expenses — copays, prescriptions and lab charges are paid out of your pocket. FSAs are tax-advantaged accounts where you can save money to help you pay these extra costs.

These days, rising health care costs are straining people’s finances. It’s not just a sudden doctor’s visit; increasing numbers of Americans are now saddled with high-deductible health insurance plans that can burden them with thousands of dollars in out-of-pocket health care costs.

What is a flexible spending account?

A flexible spending account is an account provided by some employers that allows people to save for medical expenses. FSAs can only be used for certain medical expenses, which we’ll cover later in this story. 

The biggest benefit of an FSA are the pre-tax contributions you make to the account. Pre-tax contributions help lower your income tax burden.

Individuals who are self-employed aren’t eligible for FSAs.

How does a flexible spending account work?

Contributions to your FSA come out of your paycheck, similar to a 401(k) or health insurance premiums. You decide how much you would like to contribute to your FSA every year, and some employers will also contribute funds to your FSA as part of a defined benefit plan. 

When you enroll in an FSA, you’ll receive a designated debit card to use when you pay for eligible medical expenses. You can swipe it at a pharmacy when you’re buying a prescription or at your doctor’s office to make a copay. You can even use it when you get a medical bill in the mail. If your FSA doesn’t provide a debit card, you may have to pay out of pocket and submit a claim to get reimbursed for eligible expenses.

Use your flexible spending account funds — or risk losing them

In most cases, you have to use up your FSA funds by the end of each year. You may be able to file claims for eligible expenses after the plan year ends, however, those expenses typically need to have been incurred during that plan year.

If the year is ending and you still have funds left in your FSA, you should try to use them before they expire. 

There are exceptions to this rule. Clint Haynes, CFP at NextGen Wealth, says some employers may offer to let employees roll over a maximum of $500 from their FSA to the next year, or spend the remainder of their balance during a 2.5-month grace period. Ask your employer if they offer either of these options.

Once you decide how much to save in your FSA, that’s it

When it’s open enrollment time, users can decide if they want to contribute to their FSA and how much. After that window closes, their contributions are set in stone. 

You can only change your contribution amount during the year if you experience a qualifying life event specified by your plan. Here are some situations that the government considers to be qualifying life events:

• Getting married, losing health insurance as a result of a divorce or legal separation, or if someone on your health insurance plan dies.
• Having a child or adopting one, or having a child placed in foster care.
• Gaining or losing access to Medicare or Medicaid.

Ask your HR department for its FSA qualifying life event policy and make sure you understand when you can and can’t change your contributions.

Flexible spending account eligible expenses

The list of FSA-approved expenses is substantial, but it doesn’t include every health care cost you may incur. Insurance premiums, for example, are not eligible. In general, you can use FSA funds on yourself, your spouse or any dependents that are claimed on your taxes. 

Here is a sample of what you can use FSA contributions for:

Flexible spending account ineligible expenses

If you use the money on non-eligible expenses, you will be required to repay your employer.

Flexible spending account contribution limits

Contribution limits for the FSA are $2,750 for 2020, up from $2,700 in 2019. While you're usually responsible for funding your FSA, your employer may also contribute to the account. You do not have to pay taxes on employer contributions to your FSA. The money your employer puts into your FSA generally doesn’t count toward your contribution limit, but you should ask your HR department how this applies to you.

How much should you save in your FSA?

The amount you should save in your FSA will depend on a variety of factors. 

“If you have a history of reaching your deductible every year or you're planning to have a big medical expense this upcoming year, it’s wise to look at putting away as much as you can,” said Crystal Rau, a CFP at Beyond Balanced Financial Planning. “After all, why not shelter that money from taxes that you know you're going to have to spend anyway?”

To determine an appropriate contribution amount, you’ll need to think about how much you expect to pay for things like surgery, counseling, fertility treatments, dental care and other costs. Looking at what you spent on health care over the last year or two can give you an idea of what you can expect in a typical year. 

There are downsides to contributing too little or too much. If you set aside too little in an FSA, you’ll miss out on the tax benefits that come with contributing a higher amount to your account.

“The real risk is in overestimating and not being able to spend the funds by the deadline,” said Antowoine Winters, a CFP at Next Steps Financial Planning. “It is a little bit of a double-edged sword that way.”

Remember, you can’t change your contributions mid-year unless you have a qualifying life event, so it’s important to be as accurate as possible.

If you wind up with leftover funds toward the end of the plan year, you can spend them on FSA-eligible medical supplies you might need around the house, like sunblock and first-aid kits. Sites like walgreens.com and fsastore.com have designated shopping areas where you can browse FSA-eligible products. 

Advantages and Disadvantages of an FSA

FSA advantages

• FSAs can reduce your tax bill. You use pretax payroll deductions to fund your FSA. This means you’re not charged tax on that income.
• FSAs offer dedicated funds for healthcare expenses. Having money set aside for health care costs can give you peace of mind when an unexpected medical bill comes up. Your FSA funds can also be used to pay for expenses your health insurance may not cover, such as copayments and certain medications.
• It’s easy to use FSA funds. You can swipe your FSA debit card at pharmacies, doctor’s offices and other facilities to cover eligible expenses.

FSA disadvantages

• FSA funds expire. FSAs typically require that you spend the contributions within the plan year. Some employers may allow you to roll over a certain amount of contributions to the following year. If you don’t use the funds, you may lose them.
• FSAs can’t be used for every health care expense. While the list of FSA-eligible expenses is broad, it does not include things like vitamins for general health, marriage counseling, cosmetic surgery or teeth whitening.
• You usually can’t change your FSA contribution amount. Once you decide how much to contribute to your FSA during the open enrollment period, you can’t make adjustments unless you have a qualifying life event, such as a divorce.

Flexible spending account vs. health savings account (HSA)

Flexible spending accounts aren’t the only way to save money on a pretax basis for certain health care costs. A Health Savings Account (HSA) also allows you to cover qualified medical expenses with pretax payroll contributions. However, HSAs have a different set of rules and policies that offer some advantages. Here are the key differences between an FSA and an HSA: 

Rollover policy. Funds in an FSA are generally limited to use within that plan year, while the money in an HSA has no expiration date. Your HSA funds are always available for use on eligible expenses, no matter when the contribution was made. You can even designate a beneficiary of your HSA funds in the event of your death.

Contribution requirements. To contribute to an HSA in 2020, you must have a high-deductible health insurance plan with a minimum deductible of $1,400 for individuals and $2,800 for families.

Contribution limits. Contribution limits are higher for HSAs, at $3,550 for individuals and $7,100 for families. People who are at least 55 years old by the end of the year can contribute an extra $1,000 to their HSA.

Unlike with FSAs, your HSA contribution may be changed at any point, even if you don’t have a qualifying life event. Haynes said that the overall flexibility of HSAs make them a far superior choice to FSAs. If you have the option of choosing between one or the other, it’s always better to go with the HSA.

The contributions you make toward your HSA can have some benefits in retirement. Some people choose to hold onto receipts for HSA-eligible health care expenses, then submit them for reimbursement later on to get a tax-free sum in retirement. Since your contributions never expire, you could also draw from the account to cover eligible health care expenses during your retirement.