Flexible Spending Account
A Flexible Spending Account (FSA) is an employer-sponsored benefit account that allows employees to set aside pre-tax dollars to pay for eligible healthcare or dependent care expenses, reducing taxable income but subject to a use-it-or-lose-it rule that makes careful annual contribution planning essential.
Flexible Spending Accounts provide a tax subsidy for predictable out-of-pocket expenses by allowing contributions to be made with pre-tax dollars, reducing federal income tax, state income tax (in most states), and FICA taxes. For an employee in the 22% federal bracket plus 6.2% Social Security tax, 1.45% Medicare tax, and a 5% state income tax, the effective discount on FSA-eligible expenses can approach 35%, making the FSA a high-value benefit for households with routine eligible expenses.
Healthcare FSAs cover a broad range of qualified medical expenses including deductibles, copayments, prescription drugs, dental care, vision care, and many over-the-counter products (bandages, antacids, pain relievers, and pregnancy tests, among others, were added to the eligible list by the CARES Act in 2020). Cosmetic procedures, gym memberships, and premiums for health insurance are generally not eligible.
The annual contribution limit for healthcare FSAs is set by the IRS each year (indexed for inflation — $3,300 for 2025). Unlike Health Savings Accounts (HSAs), FSA funds do not roll over indefinitely. The traditional rule is strict forfeiture: any unspent balance at year-end is forfeited. IRS regulations permit employers to offer one of two relief options — either a grace period extending through March 15 of the following year to spend prior-year funds, or a carryover of up to $660 (2025 limit) in unspent funds into the next plan year. Employers may offer one relief option or neither, but not both simultaneously.
The funding mechanics of healthcare FSAs are uniquely favorable at year-start: the full elected annual amount is available from the first day of the plan year, even though contributions from payroll deductions are spread across pay periods throughout the year. An employee who elects $2,500 and has a large dental procedure in January can use the full $2,500 immediately, then effectively pay it back through payroll deductions over the remaining 11 months. This front-loading feature distinguishes FSAs from dependent care FSAs and HSAs, where only contributed amounts are available.
FSA accounts are employer-owned, not individually owned. If an employee leaves mid-year after spending more from the FSA than was contributed, the employer absorbs the loss — the employer cannot recover the shortfall. Conversely, if the employee leaves after contributing more than was spent, unspent funds are forfeited to the employer rather than returned.