Legal Definitions - flexible savings account (FSA)

A Flexible Savings Account (FSA) is an employer-sponsored benefit that allows employees to set aside money on a pre-tax basis to pay for eligible out-of-pocket healthcare expenses. It's a way to save money on taxes while covering common medical, dental, and vision costs for themselves, their spouse, and their dependents.

When an employee chooses to participate in an FSA, they decide how much money to contribute for the year, up to an annual limit set by the IRS. This amount is then deducted from their paycheck before taxes are calculated, effectively reducing their taxable income. Employers may also contribute to an employee's FSA. The funds in an FSA can be used for a wide range of qualified medical expenses that are not covered by health insurance, such as co-payments, deductibles, prescription medications, certain over-the-counter drugs, and medical equipment.

A key characteristic of an FSA is the "use it or lose it" rule, meaning that generally, any money not spent by the end of the plan year is forfeited. However, some employers offer a grace period or allow a limited amount to be carried over to the next year. Because contributions are made with pre-tax dollars and reimbursements for qualified expenses are tax-free, an FSA provides a significant tax advantage for managing healthcare costs. FSAs are only available through an employer and are not an option for self-employed individuals.

• Example 1: Managing Routine Family Healthcare Costs

  Sarah works for a tech company and has two young children who frequently need doctor visits for colds, annual eye exams, and occasional prescription refills. Sarah enrolls in her company's FSA and elects to contribute $1,500 for the year. Each month, a portion of this amount is deducted from her paycheck before taxes. Throughout the year, she uses her FSA funds to pay for her children's pediatrician co-pays, new glasses for her son, and the cost of prescription antibiotics, saving money because these funds were never taxed.

• Example 2: Covering an Unexpected Medical Expense

  David works for a marketing firm and unexpectedly needs a root canal, which his dental insurance only partially covers, leaving him with a $700 out-of-pocket expense. David had already contributed $1,000 to his FSA for the year. Even though he hasn't had all the money deducted from his paychecks yet, the full $1,000 is available to him from the start of the plan year. He uses $700 from his FSA to pay for the root canal, meaning he pays for this significant expense with money that was never subject to federal income or payroll taxes.

• Example 3: Supporting Ongoing Health Management

  Maria, an accountant, manages mild asthma and frequently purchases specific over-the-counter allergy medications, a nebulizer, and replacement parts for it, none of which are covered by her health insurance. Maria contributes $800 to her FSA annually. She uses these pre-tax funds to purchase her approved allergy medications and the nebulizer supplies throughout the year. This allows her to manage her chronic condition more affordably, as the money she spends on these necessary items is effectively discounted by the amount she would have paid in taxes.