What Is an FSA?

Flexible spending accounts (FSAs) can be a lucrative benefit to offer as part of your health insurance offerings. Here are some important details about FSAs. Paychex can help you offer an FSA for your small, large, or enterprise-level business today.

A health care flexible spending account (Health FSA) allows employees to use pre-tax dollars to pay for eligible out-of-pocket healthcare expenses such as co-pays, prescription and over-the-counter medications, vision care, and dental work, for themselves, their spouse, and eligible dependents. These account-based plans are voluntary, and employers can make contributions on top of employees' pre-tax contributions.

In the United States, health care ranks as one of the most sought-after employee benefits, as employees want the reassurance of medical coverage for themselves and their family. To extend the usefulness of these benefits, an FSA can be offered to further assist with managing medical costs.

It's important to note that Health or Medical FSAs are not the same as health savings accounts (HSAs), although the two have similarities. Both allow enrollees to save money to pay for qualified medical expenses with pre-tax dollars, but there are key differences between these arrangements.

How Does a Health FSA Work?

An Health FSA is a voluntary plan that allows enrolled workers to contribute up to an annual maximum of $3,050 in 2023 to pay for eligible medical expenses not covered by their health insurance. If your business offers group health insurance, you can offer your workers this additional benefit.

Additionally, employers may choose to subsidize or match workers' Health FSA contributions. Employer contributions generally do not count toward the FSA limits for contributions, unless employees elect to receive the employer contributions in cash or as a taxable benefit.

The Different Types of FSAs

While most employees are familiar with health care FSAs, there are other types of flexible spending accounts that allow pre-tax dollars to be spent on a specific category of costs. Each type of FSA has its own contribution limits and definition of qualifying expenses.

Health Care FSA

Employees may contribute pre-tax dollars from their paycheck to a health FSA. Employers may also contribute to a health FSA on an employee's behalf. Funds in the account must be used to cover the cost of qualifying medical expenses, including dental and vision care.

Qualified Transportation Fringe Benefits FSA (Commuter Benefit)

A qualified transportation Reimbursement Account (Section 132 (f)) FSA, also called a TRA, allows employees to set aside pre-tax dollars for commuting expenses such as parking at work, mass transit passes, and vanpooling. In 2023, the IRS permits contributions of up to $300 per month to a qualified transportation reimbursement account FSA for transit and the cost of rides in a commuter highway vehicle (vanpooling), and another $300 per month for qualified parking expenses.

Dependent Care FSA

Employees can use a dependent care FSA to save funds in a tax-advantaged account to pay for expenses related to care for a child under the age of thirteen or an adult dependent who is unable to care for themselves. Qualifying expenses include the cost of adult or child day care, preschool tuition, in-home caregiving, or day camp. For 2023, the dependent care FSA contribution limit is $5,000, or $2,500 for those with a married, filing separately tax status.

Limited Purpose Health FSA

A limited purpose health FSA is available to employees enrolled in a qualified high-deductible health plan (qualified HDHP) who use an HSA for medical expenses. The limited purpose health FSA provides employees with the ability to use pre-tax dollars to pay for dental and vision expenses not covered by the qualified HDHP. For 2023, plan participants may contribute $3,050 into a limited purpose health FSA.

Benefits of an FSA

An FSA offers benefits to both employees and employers. Some of the most important advantages include tax savings and more effective management of employees' out-of-pocket medical costs.

• Employer tax savings: Employers pay less in their portion of FICA and FUTA payroll taxes, as employee contributions to an FSA are not subject to these taxes.
• Medical savings: Enrolled workers use pre-tax dollars (an annual maximum of $3,050 for 2023) to pay medical expenses not covered by their health insurance.
• Effect on take-home pay: Employees can contribute a set amount of pre-tax dollars toward their FSA balance to cover medical expenses. This may give employees more take-home pay because they pay less in taxes.
• Immediate access to account: Funds can be monitored online and employees can gain immediate access to their account through an FSA debit card.
• Evenly spaced savings to manage costs: FSAs allow employees to save evenly throughout the year, which helps to budget and manage large healthcare costs. Carryover rules also help to limit last-minute spending to avoid the "use it or lose it" mentality.
• No required payback of reimbursed funds: FSAs require that contributions come from each paycheck throughout the year, but the full annual contribution amount is available for use immediately (or after the first contribution). If the employee uses the full amount and then quits or is fired before year-end, they do not have to repay FSA funds to the employer.

FSA Eligibility

It's up to employees to decide how much they want to contribute to an FSA using payroll deductions. Typically, participants use their contributions to an FSA to reimburse themselves for co-payments and other out-of-pocket, non-covered medical expenses. Most dental expenses also qualify, such as costs for non-cosmetic orthodontics and extractions.

Our full list of eligible FSA items can be found here: What's Eligible for FSA?.

What Are the 2023 Limits of an FSA?

Health care and limited purpose health FSA contribution limits equal $3,050 for 2023. These amounts are generally adjusted each year for inflation. Dependent care FSA limits are $5,000 for single filers and married couples filing jointly, and $2,500 for married couples filing separately. The maximum amount of pre-tax dollars that may be saved in a transportation FSA equals $300 for transit passes and vanpooling, and $300 for qualified parking expenses, or a total of $600 per month.

Employer Advantages of Offering an FSA

The value of FSAs extends to employers who often see increased retention rates and employee satisfaction as a result of offering this flexible benefit. There are also notable tax advantages. Because enrolled employees reduce their taxable income with FSA contributions, employers pay less in Medicare and Social Security (FICA) taxes. The more employees who enroll, the more savings for the company.

FSAs also enhance one of the benefits employees’ value most: healthcare coverage. Such accounts allow employers to help their workers and their dependents pay for qualifying medical expenses not covered by the group insurance plan — a benefit that contributes significantly to employee retention, morale, and loyalty.

Considerations for Employers and Employees

If you wish to offer employees an FSA, the timing of your decision is imperative. Ideally, your new FSA should be ready to go prior to open enrollment for the following year. This will allow employees to do their research and make their plan elections accordingly. If you currently offer an FSA and need to amend your plan, be sure to communicate any changes to participants.

Before enrolling in a health or limited purpose health FSA, employees should attempt to project their reimbursable qualifying medical or dental and vision expenses for the year and decide if it makes sense to set aside money each pay period to cover them. You don't want to lose contributed funds when you don't have the necessary medical expenses. Looking back at past years' expenses can help determine if it makes sense to enroll in a health FSA.

What Is a Health or Limited Purpose Health FSA Carryover or Grace Period Option?

Although not required, employers have two options they can institute to help employees take advantage of all the money they've contributed into their health FSAs.

• Allow employees to carry over up to $610 of unused health FSA money at the end of the year to apply to the next plan year (remaining funds in excess of $610 are still forfeited to the plan); or
• Elect a grace period to permit employees to use their unused account balances to pay for qualifying medical costs incurred during the first 2.5 months of the next plan year or prior plan year (up to March 15 for calendar year plans) before they must forfeit the money.

Before making a final decision, employers should carefully weigh the benefits of any insurance benefit account like a health FSA and also understand the administrative requirements of a carryover or grace period option.

When Do You Need To Pick the Health or Limited Purpose Health FSA Carryover or Grace Period Option?

Both options are intended to reduce "wasteful" end-of-year spending as employees hurry to spend their health or limited purpose health FSA money rather than lose the funds. Employers are not required to offer either option, in which case the traditional "use it or lose it" rule will still apply. But if you do choose to offer one of these options to your workforce, you must pick only one, as employers cannot allow employees both a carryover and a grace period for their health FSA. You may wish to review any available data on current FSA usage before deciding which option would work best for your company's workforce. Once you make your selection, notify employees as soon as possible to give them enough time to make an account selection and adjust their medical spending as needed.

Communicating FSA Benefits to Employees

If you want employees to take full advantage of an FSA benefit, you must strive to clearly communicate how they can best use the plan. A well-drawn benefits communication strategy can enhance your employees' understanding of how to enroll in the FSA and receive the maximum benefits. While information on FSAs should be included in open enrollment, it must also be provided to new hires when they become eligible for benefits. FAQs and other health plan information may also be provided online via a company benefits portal. Keeping in mind that employees' communication preferences may vary, you may want to make printed copies of this information as well. A strong communication plan should consider the following:

Educating Employees

Communications efforts should be designed to educate employees on the benefits of an FSA. Explain why they might want to use this type of plan. Commonly asked questions and examples that break down different cost scenarios can be helpful, along with key enrollment dates. You'll also want to remind employees about any FSA spending deadlines and clearly explain the carryover or grace period options made available to them.

Avoiding Jargon

Aim to make your communications easy to understand and present them in a conversational tone, where possible. An FSA grace period is often referred to as the "2.5 month grace period." This may make perfect sense to HR professionals, but your staff may be confused by such types of industry jargon. When you communicate the details of the FSA grace period to employees, for example, describe it using specific dates and deadlines. Also, communicate what will happen if they fail to take action, such as a forfeiture of contributions.

Providing Helpful Tools

Janelle Rodriguez, Paychex HR consultant, suggests resources like the Paychex FSA enrollment material, which offers a list of expenses-at-a-glance for enrollees to review. "Paychex partners with the FSA Store, which also provides an expansive list of items that are FSA-eligible, while also offering a means for employees to use their funds." She says a quick reference tool (like a one-pager or web page) listing common items employees can use their FSA funds to pay for is also helpful. These useful types of communications tools can take the burden away from busy HR professionals.

Setting Up an FSA

If you're not currently offering an FSA, this can bring tax savings for both you and employees as well as provide a much-desired add-on to your health benefits. Paychex offers assistance with FSA implementation, ongoing administration, and the development of employee communications to encourage participation.

FSA Frequently Asked Questions

What Happens to FSA funds if an Employee Quits?

An FSA is owned by the employer and not the employee. When an employee leaves the company, they cannot take the unused funds with them. However, the employee may receive reimbursement for any qualified medical expenses incurred before their last day of work, even if bills are received after they leave the company during a specific Run-Out Period. Any remaining balance is forfeited.

How Much Can You Carry Over in Your Health or Limited Purpose Health FSA?

The ability to carry over funds to the next plan year is permitted at the employer's discretion. If the employer allows for carryovers, the 2023 limit is $610. Alternatively, the employer may provide employees with a 2.5 month grace period to use remaining funds from the prior year. The employer may give either a carryover allowance or a grace period, but not both.

Can You Get an FSA Outside of Work?

FSAs can only be obtained through an employer. Individuals cannot open a flexible spending account outside of work. While those who are self-employed cannot access an FSA, they may set up an HSA when enrolled in a qualified high-deductible health plan (qualified HDHP).

Are All Medical Expenses Covered by a Health FSA?

A Health FSA covers only qualifying medical expenses. Although this term encompasses a long list of items, some medical expenses are not covered by a health FSA. These costs may include cosmetic procedures, vitamins (unless prescribed by a physician), and personal care items such as toothpaste.