What is a Flexible Spending Account (FSA)?

How does it Work?

The Flexible Spending Account allows deducting a specific amount from your regular earnings frequently. Such a deduction lowers theThe taxable income formula calculates the total income taxable under the income tax. It differs based on whether you are calculating the taxable income for an individual or a business corporation.read more taxable incomeTaxable IncomeThe taxable income formula calculates the total income taxable under the income tax. It differs based on whether you are calculating the taxable income for an individual or a business corporation.read more of the individual. Lower taxable income leads to a lower tax liability for the individual as the deduction is made from earnings before taxes.

The IRS provides a maximum limit on the contribution to such an account. If the individual is married, the limit applies separately to the spouse through the spouse’s employer. Per the revised limits in 2020, the per-employee limit for medical expenses is $ 2750 compared to $ 2700 in the calendar year 2019.

Further, the employer may also contribute to the FSA of the employee as per his discretion. However, such contribution by the employer is voluntary.

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Types of Flexible Spending Account

#1 – Dependent Care FSA

It is also called a “dependent care reimbursement account” (DCRA). This account is used only for the expenses of the dependent person. Expenses such as day-care, elderly care or preschool, or any other dependent expenses are allowed under such an account.

#2 – Health Care FSA

The funds accumulated in such an account can be used for medical, vision, dental expenses, or any other qualified expenses. Usage for non-qualified purposes is usually not allowed.

#3 – LPFSA

It stands for Limited Purpose Flexible Spending Account. It can be used along with a health savings account. The available funds can be used for dental or vision expenses or any other purpose as notified.

#4 – PDFSA

It stands for Post Deductible Flexible Spending Account. The IRS allows a minimum deductible amount. These funds are used for section 213d medical expenses if the minimum deduction limit is achieved.

Limit and Grace Period of Flexible Spending Account

  • Even if the account name is “flexible” spending, you must use the funds within the plan year itself. However, the employer may allow grace periodGrace PeriodGrace periods are extra days given after the due date to undertake an unfulfilled obligation without penalties. They are a common instance in the financial world and are usually offered to clients who apply for a credit card, student loan, insurance, or mortgage to attract more customers.read more of up to 2.5 months over & above the normal tenure to let you use the funds of the said account.On the other hand, the employer may allow you to carry forward the amount to $ 500 per annum in the next plan year. The employer will provide either of these options at his discretion.If the funds are not utilized within the plan year or the grace period, the pending balance amount is not refunded back to you. Thus, it would be best if you strategically thought over the amount of contribution to be made in FSA.

Flexible Spending Account Eligibility List

The IRS is very concerned about what is included in the term “medical care.” As per the definition of medical care, it should relate to diagnosis, mitigation or treatment, or prevention of disease, cure, or the care of any part or function of the body. The funds out of FSR are eligible to be spent for the following purposes:

  • Purchase of health care products over the counterPayments for doctors visit of expensesPayment for prescribed medical needsDental expensesVision expensesFirst aid supplies expensesExpenses for prescribed eyeglasses

Benefits

  • Urgent medical needs of the employee are taken care of.The amount contributed is provided as an exemption from taxable income, which lowers the individual’s taxable income. Lower taxable income results in lower tax liability for the individual.Needs for dependent care or children care are also taken care of.The employee is saved from the stress of managing the expensesExpensesAn expense is a cost incurred in completing any transaction by an organization, leading to either revenue generation creation of the asset, change in liability, or raising capital.read more in case of medical emergencies.

Disadvantages 

  • There is an expiry period for the amount deposited. The hard-earned money is lost if you do not use the funds within the said period. However, the employer may provide an option for a grace period or carry forward the amount.There is an upper cap of $ 2750 (for the calendar year 2020). If the actual expenses exceed the said amount, the employee needs to bear the remaining amount.Flexible savings accounts are linked to the employer. If you leave the job, you cannot carry forward the benefits to the new employer.No deduction is allowed for actual spending of the amount.

This has been a guide to What is a Flexible Spending Account & its Definition. Here we discuss its types, how it works, benefits and disadvantages. You can learn more about it from the following articles –

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