What is a Flexible Spending Account (FSA)? Explained & faqs

Healthcare tends to have a ton of acronyms which can be incredibly confusing. What's more, it's difficult to judge what products and services do, how they work, and what makes one more desirable than another. 

FSAs, or Flexible Spending Accounts, illustrate the issue perfectly. The phrase tells us very little, which makes talking about uses, benefits, and issues more difficult than it needs to be. Even for those in the know (and we’ll do our best to get you there), FSAs are frequently the subject of questions such as:

• Who’s eligible for FSAs?
• How much can you contribute to an FSA?
• What expenses are covered by FSAs?

With that in mind, we’ll take a deep dive into FSAs and answer all your questions on this essential employee benefit.

Key takeaways

• FSAs are tax-advantaged spending accounts that are used to cover a variety of medical expenses.
• Employers can offer FSAs as part of their benefits package, making it easier for employees to cover eligible healthcare costs.
• FSAs are subject to a number of rules: they have an annual contribution limit, a use-it-or-lose-it policy, and are mutually exclusive with HSAs (Health Savings Accounts).
• FSAs have a number of sub-types, including Medical FSAs, Dependent Care FSAs, and Limited Purpose FSAs.

What is a Flexible Spending Account?

A Flexible Spending Account (FSA) is a pre-tax financial account that allows employees to set aside a portion of their pre-tax earnings to pay for qualified medical expenses of the participant, spouse or eligible dependents.

The most common type of FSA is used to pay for medical and dental expenses not paid for by insurance, usually deductibles, copayments, coinsurance for the employee's health plan and other out-of-pocket medical expenses.

FSAs are a part of Forma’s line of pre-tax products, including:

• HSAs
• Dependent Care FSAs
• Healthcare FSAs
• Commuter accounts
• COBRA
• And more.

Forma enables you to customize your benefits packages by offering these accounts at scale, giving employees a strong incentive to remain within your organization.

You can learn more about Forma FSAs on our Pre-tax Accounts page.

How Flexible Spending Accounts work

Employees usually enroll in an FSA during their employer's open enrollment period, which typically occurs annually.

During this period, employees decide how much money they want to contribute to the FSA for the upcoming plan year.

FSA contributions are deducted from employee paychecks on a pre-tax basis pro rata throughout the plan year. This reduces the employee's overall taxable income, resulting in lower income tax liability and saving money for both the employee and employer.

The Internal Revenue Service (IRS) sets annual contribution limits for FSAs. As of 2023, the limit for healthcare FSAs is $3,050, and employers may set a lower limit. Contribution limits are typically increased annually, and for 2024, they are set to $3,200.

Funds contributed to an FSA can be used to cover eligible medical expenses. Eligible medical expenses include but are not limited to:

• Prescription eyeglasses, contact lenses, and related supplies.
• Certain medical equipment such as crutches, wheelchairs, and home medical supplies.
• Dental cleanings, X-rays, braces, and other dental treatments.
• Over-the-counter medications such as Tylenol, Ibuprofen, Emergen-C, Epsom Salt, Lactaid, Metamucil, Nutrafol, Flonase, Miralax, Mucinex, and Zyrtec.
• Acupuncture, chiropractic services, laser skin treatment, and other treatments if you have a Letter of Medical Necessity (LMN).

Employees can access their annual contribution at the beginning of the plan year, even if they haven't contributed the full amount through payroll deductions. This allows immediate use of the funds for eligible expenses.

When participants incur eligible expenses, they submit reimbursement claims to the FSA administrator. In the case of Forma, we also provide a Forma VISA debit card for convenient payment at the point of service.

Participants may need documentation, such as receipts or explanations of benefits (EOBs), to support their reimbursement claims, especially for certain expenses.

Pros and cons of Flexible Spending Accounts (FSAs)

FSAs come with their share of pros and cons. We will consider them from two sides: that of the employer and that of the employees.

FSA pros and cons for employers

Pros

1. Tax benefits - Employers benefit from payroll tax savings as FSA contributions are made on a pre-tax basis. This can reduce the employer's overall payroll tax liability.
2. Employee satisfaction - Offering FSAs as part of the benefits package enhances employee satisfaction. Employees appreciate the opportunity to use pre-tax dollars to cover their medical expenses.
3. Attracting and retaining talent - Competitive benefits, including FSAs, can be valuable for attracting and retaining talented employees. It adds to the overall appeal of a compensation package.
4. Reduced healthcare costs - By encouraging employees to use FSAs for routine medical expenses, employers may contribute to a reduction in employees' healthcare costs over time.
5. Health and productivity - Helping employees manage their healthcare costs may contribute to a healthier and more productive workforce.

Cons

1. Administrative burden - Administering FSA programs involves administrative work, including managing employee contributions, claims, and compliance. This can add to HR responsibilities. However, you can completely sidestep this issue by using Forma to consolidate benefit offerings onto a flexible benefits platform.
2. Use-it-or-lose-it dynamics - The "use-it-or-lose-it" rule may result in some employees scrambling to spend their FSA funds at the end of the plan’s year, which can create administrative challenges. Forma can help alleviate the negative effects of use-it-or-lose-it. With Forma’s user-friendly interface, you can easily manage employee FSAs, notify users about important deadlines, and allow employees to utilize FSA funds via the Forma Card and submit claims through our reimbursements team. Finally, note that the IRS has a provision that some funds may be carried over to the next year if the employer allows it. The carry-over limit for 2024 is $640, as per the IRS Revenue Procedure 2023-34.
3. Employee education - Employers need to invest time in educating employees about the benefits and rules of FSAs to ensure that participants maximize the advantages and understand the limitations. Forma addresses this by providing our clients with an onboarding manager that guides your team through the process.
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‍Join Forma to offer FSAs as part of your flexible benefits package.

FSA pros and cons for employees

Pros

1. Tax savings - The primary advantage for employees is the opportunity to save on taxes by contributing to an FSA with pre-tax dollars, reducing their overall taxable income.
2. Financial flexibility - FSAs provide a financial cushion for anticipated medical expenses, offering flexibility and convenience in covering co-pays, deductibles, and other eligible costs.
3. Employer contributions - Some employers contribute to employees' FSAs, providing additional funds that employees can use for medical expenses.
4. Convenient payment - Using debit cards and other convenient payment methods makes it easy for employees to access and use their FSA funds at the point of service. Our own Forma Card was designed specifically to work with FSAs, offering employees seamless claims reimbursement, as well as an auto-substantiation rate greater than 85%. 
5. Immediate access to full annual contribution - Employees have access to the total annual contribution amount at the beginning of the plan year, even if they haven't contributed the full amount through payroll deductions.

Cons

1. Letting the funds go to waste - The risk of forfeiting unused funds at the end of the plan year can be a significant drawback for employees who don't spend their entire FSA balance. However, with Forma, you can customize your FSA benefits package to offer a grace period or carryover to mitigate the loss of unused contributions.
2. Complexity in planning contributions - Employees must estimate their expected medical expenses for the upcoming year to determine the appropriate contribution amount, which can be challenging and may result in unused funds. Forma's effective communication helps you plan your FSA contributions in advance.
3. Dependency on employer - FSAs are tied to the employer, and if an employee changes jobs, they may lose access to their FSA funds. However, if your employer uses Forma, they can provide the option to continue using your FSA under COBRA.

A breakdown of the 3 types of FSAs

In this article, we’ve talked about Healthcare FSAs, the most common type of FSA. There are two other types of FSA with a more narrow use.

They are called Limited Purpose FSAs (LP FSA) and Dependent Care FSAs (DC FSA).

Let’s compare the three FSA types.

1. Healthcare FSA

Healthcare FSA, also called medical FSA, allows employees to use pre-tax dollars to pay for qualified medical expenses not covered by insurance, including but not limited to:

• Doctor's visits and copayments
• Prescription medications
• Deductibles and coinsurance
• Vision care expenses (glasses, contact lenses, eye exams)
• Dental expenses (cleanings, fillings, orthodontia)
• Over-the-counter medications (with a prescription, in some cases)
• Certain medical supplies

2. Limited Purpose FSA (LPFSA)

A Limited-Purpose FSA is specifically designed for employees with a Health Savings Account (HSA) and a high-deductible health plan. It covers qualified dental and vision expenses but not general medical expenses. Limited-purpose FSAs generally cover the participant, their spouse, and eligible dependents for qualified dental and vision expenses.

3. Dependent Care FSA (DCFSA)

A Dependent Care FSA is used to cover eligible dependent care expenses, such as childcare or adult daycare services in certain circumstances. DCFSAs have a separate contribution limit, which is $5,000 annually for single employees or married employees filing taxes jointly or $2,500 for married employees filing taxes separately.

Here is a table that summarizes the differences between these FSA types:

As an employer, setting up different types of FSAs gives employees even more flexibility with how they spend their pre-tax healthcare contributions. This improves job satisfaction and can lead to higher employee retention rates.

Some employers are reluctant to offer more FSA types to avoid adding extra complexity to their benefits program. However, with Forma, you can eliminate the administrative burden of setting up additional FSA account types. You can offer LP FSAs and DC FSAs at scale through the Forma Administrative Dashboard.

Flexible Spending Accounts (FSAs) FAQs

What’s the difference between HSA and FSA?

HSAs (Health Savings Accounts) and FSAs are both designed to help employees cover qualified medical expenses. But they function a bit differently.

The main difference is that HSAs and FSAs are individually owned accounts while FSAs are employer-sponsored accounts. FSAs and HSAs are not compatible. If you have a High Deductible Health Plan (HDHP) and a matching HSA, you are not eligible to enroll for a Healthcare FSA. The only way to combine HSA with FSA is to use a LPFSA, a FSA type that is specifically designed for this scenario.

Here are the other differences:

For more information, you can read our blog on FSA vs HSA.

Can you use FSA for copays?

You can use a Flexible Spending Account (FSA) to cover copayments (copays) for eligible medical expenses. Copays are common out-of-pocket costs associated with visits to healthcare providers or obtaining prescription medications.

FSA can be used for prescription medication copays, doctor's visit copays, specialist visits, and preventative care.

Can you use FSA for gym membership?

In contrast to Lifestyle Spending Accounts (LSAs), the IRS generally does not consider general fitness or gym memberships as eligible expenses for reimbursement from an FSA. However, there are some situations in which a gym membership may be considered an eligible expense for reimbursement from an FSA.

A prescribed exercise program and a weight loss treatment designed to treat a specific medical condition would be a great example of such exceptions. A Letter of Medical Necessity (LMN) from a healthcare provider is needed to reimburse these types of expenses.

Is an FSA worth it?

FSAs are a worthy investment for both employers and employees. On the employers' side, they are a worthwhile addition to your benefits package, offering strong incentives to employees to remain within your workforce.

For employees, FSAs offer a convenient way to cover healthcare expenses with pre-tax dollars, reducing your overall income tax liability. They are a system that works for both sides, a rarity within the health insurance sector.

If you want to provide convenient access to FSAs at scale within your organization, consider using Forma as your main benefits platform and <span class="text-style-link text-color-blue" fs-mirrorclick-element="trigger" role="button">schedule a consultation</span> with one of our experts.

*This document is for informational purposes. Forma is not engaged in the practice of law. Nothing contained herein is intended as tax or legal advice nor is it intended to replace tax or legal advice from counsel. If you need tax or legal advice, please consult with counsel or a certified tax professional.