Is an FSA Right for You?

Last month, we talked about the tax benefits of an HSA. This month, we’re focusing on FSAs. They’re similar to HSAs in many ways but very different in others. If you missed the previous article, click here.

FSAs Defined

An FSA, or flexible spending account, is an account set up by an employer to help employees pay for health-related expenses not covered by insurance. Employees must opt into an FSA program and make contributions to the account via payroll deduction. 

With an FSA, you’re essentially putting money in a separate account to reimburse yourself for qualifying expenses. FSA plans vary by employer, but generally, the funds can be used for expenses like medical deductibles and copayments, prescription eyewear, first aid products, and over-the-counter medications purchased with a doctor’s prescription. Some FSAs allow employees to be reimbursed for other health-related items, like gym memberships, massage therapy, and acupuncture. What’s covered and what isn’t is dependent on the plan. 

Tax Implications

Contributions made to an FSA are not tax deductible, but there is a tax benefit to having an FSA. Since contributions are made with pretax income, your taxable income is lower, meaning you’ll pay less to the IRS at tax time. 

There’s a limit to how much you can put in an FSA each year, and you don’t have to contribute the maximum amount. For the 2022 tax year, the most you can contribute is $2,850. That amount will go up to $3,050 in 2023.

An FSA Is Not an HSA

Because FSAs and HSAs work similarly, covering out-of-pocket medical expenses, many think they’re the same type of account. But that’s not true. An HSA is individually owned; an FSA is employer-owned. With an HSA, the money contributed each year rolls into the new year. With an FSA, unused funds most likely don’t roll over — or if they do, they do so with stipulations. 

Use It or Lose It

The use-it-or-lose-it aspect of an FSA sometimes trips people up at the end of the year. If they’ve contributed the maximum amount to the FSA but haven’t accumulated enough costs to reclaim it all, they may lose a chunk of their hard-earned money. 

The IRS does give employers the option of allowing employees to use the funds in the FSA until March 15 of the following year. Employers can also let employees roll up to $500 of the unused funds into the next calendar year. But these options are at the discretion of the employer. Check the rules on your FSA plan to ensure you’re not caught off-guard at the end of the year.

Make It Work for You

Regardless, try not to over-fund your FSA. Estimate how much you think you’ll spend on out-of-pocket expenses during the year, and then only contribute that much. That way, you reduce the chance of losing unused funds at year-end.

Another thing to be aware of is that participation in an FSA usually isn’t automatic. You may have to sign up at the beginning of each year to continue using an FSA for expense reimbursement.

Where Do HRAs Come In?

To go even deeper into the weeds, some employers offer HRAs. An HRA is similar to an FSA but with a couple of differences. While the FSA is employee-funded, an HRA is employer-funded. Employees can use the money in an HRA the same as they would an FSA, except that HRA funds cannot be withdrawn prior to an expenditure. Also, qualifying expenses may differ from an FSA.

Employers offering an HRA can claim employee reimbursements as tax deductions. Reimbursements received by employees under an HRA are generally tax-free.

Need More Information?

Your company’s plan administrator is the best source for specific details on your company’s FSA. But if you need additional information about the tax benefits of offering or contributing to an FSA, Adams Accounting Solutions can help. We specialize in tax preparation for individuals and small business owners. We’ll help you determine whether an FSA works well for your tax situation or not. Give us a call today!