Flexible Spending Accounts (FSA)

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What is a flexible spending account (FSA)?

A flexible spending account (FSA) is a type of employee benefit plan that allows employees to set aside a portion of their earnings on a pre-tax basis to pay for certain out-of-pocket health care and dependent care expenses. The funds in an FSA are not subject to federal income taxes, Social Security taxes, or Medicare taxes, which can result in significant savings for employees.

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Image showing the meaning of a flexible spending account

FSAs are typically offered by employers and are administered by third-party administrators. FSAs typically have a annual contribution limit and also have a “use it or lose it” provision, which means that any funds that are not used by the end of the plan year will be forfeited.

Characteristics of a flexible spending account (FSA)

Flexible Spending Accounts (FSA) have several characteristics, including: According to HBR’s compensation research, FSAs are among the most tax-efficient employee benefits available — delivering roughly $0.30 in tax savings for every dollar contributed by employees in higher tax brackets.

  1. Pre-tax Deductions: FSAs allow employees to set aside a portion of their earnings on a pre-tax basis to pay for certain out-of-pocket health care and dependent care expenses.
  2. Tax Savings: The funds in an FSA are not subject to federal income taxes, Social Security taxes, or Medicare taxes, which can result in significant savings for employees.
  3. Employer-sponsored: FSAs are typically offered by employers and are administered by third-party administrators.
  4. Annual Contribution Limit: FSAs typically have an annual contribution limit, which is set by the employer and the government.
  5. Use-it-or-lose-it Provision: FSAs have a “use it or lose it” provision, which means that any funds that are not used by the end of the plan year will be forfeited.
  6. Eligible Expenses: FSA funds can only be used to pay for certain qualified expenses such as medical, dental and vision care, prescription drugs, and dependent care expenses.
  7. Limited Portability: FSAs are not portable, meaning that the funds in the account belong to the employer and cannot be transferred to another plan or employer.
  8. Limited Rollover: Some plans allow for a limited rollover of funds from one plan year to the next, but typically the funds remaining at the end of the plan year will be forfeited.
  9. Enrollment Requirement: Employees are typically required to enroll in an FSA during open enrollment periods, and once enrolled, they cannot make changes to their election until the

Why are flexible spending accounts (FSA) essential?

Flexible Spending Accounts (FSA) are essential because they provide several key benefits, including: SHRM’s total rewards guidance recommends year-round FSA employee education — not just during open enrollment — to maximize participation and ensure employees understand the use-it-or-lose-it rule before year-end.

  1. Tax Savings: FSAs allow employees to set aside a portion of their earnings on a pre-tax basis, which can result in significant savings on federal income taxes, Social Security taxes, and Medicare taxes.
  2. Cost-effective Healthcare: FSAs can help employees pay for out-of-pocket health care expenses, such as co-pays, deductibles, and prescriptions, which can be especially beneficial for employees with high medical expenses or those who are underinsured.
  3. Dependent Care Assistance: FSAs can also be used to pay for dependent care expenses, such as daycare or babysitting, which can be especially beneficial for employees with families.
  4. Budgeting Tool: By setting aside money in an FSA, employees can better manage their health care and dependent care expenses, rather than having to pay for these expenses out of pocket.
  5. Employer Benefit: Employers who offer FSAs as a benefit can attract and retain employees, and can also save on payroll taxes.
  6. Legal Compliance: Employers who offer FSAs as a benefit can also comply with legal requirements such as the Affordable Care Act (ACA) which mandate certain types of health care benefits for employees.
  7. Simplicity: FSAs are relatively simple to administer, and third-party administrators are available to help employers set up and manage the accounts.

FSAs are a high-value, low-cost benefit that strengthens total rewards competitiveness. Organizations using pre-employment assessments ensure every hire is grounded in verified skills. A data-driven hiring plan reduces mis-hire risk, while strong talent acquisition practices focused on skills-based hiring help organizations attract and retain top talent.

Frequently asked questions

An FSA is an employer-sponsored benefit account allowing employees to set aside pre-tax dollars to pay for eligible out-of-pocket healthcare expenses (healthcare FSA) or dependent care expenses (dependent care FSA). Contributions reduce taxable income for both employee and employer. The healthcare FSA annual limit for 2024 is $3,200; dependent care FSAs are limited to $5,000 per household.

Both allow pre-tax savings for healthcare expenses. Key differences: HSAs require enrollment in a high-deductible health plan (HDHP); FSAs are available with any health plan. HSA funds roll over indefinitely; FSA funds generally must be used by year-end (though employers can offer a $610 rollover or 2.5-month grace period). HSA accounts belong to the employee; FSAs belong to the employer. HSA contribution limits are higher.

FSA funds must be used within the plan year or they are forfeited. Employers can offer one of two options: a $610 rollover amount (2024) to the next year, or a 2.5-month grace period after year-end to incur eligible expenses. Many employees are unaware of this rule and forfeit funds. HR best practice is active education campaigns in Q3 and Q4 reminding employees to use their balances.

Healthcare FSA eligible expenses include most out-of-pocket medical, dental, and vision costs: deductibles, copays, prescriptions, orthodontia, glasses and contacts, and a wide range of OTC medications and health products (expanded post-CARES Act). Dependent care FSA covers daycare, after-school programs, and elder care for tax dependents while the employee (and spouse) works or looks for work.

Employees save on income tax — contributions are pre-tax, reducing their taxable wages. Employers save on payroll taxes (FICA) on employee FSA contributions — typically 7.65% of each contributed dollar. For an employer with 100 employees each contributing $1,000, FICA savings could reach $7,650 annually. FSAs also enhance benefits competitiveness and employee financial wellbeing at relatively low administrative cost.

FSAs require: selecting a third-party administrator (FSA plan administrator), establishing IRS Section 125 cafeteria plan documents, conducting annual open enrollment with contribution election, issuing FSA debit cards or reimbursement mechanisms, managing substantiation requirements, handling mid-year qualifying event changes, and communicating deadlines and eligible expenses year-round. Most HRIS and benefits platforms integrate FSA administration.