FSA
An FSA (Flexible Spending Account) is an employer-sponsored account in which you set aside pre-tax income to pay for qualified medical or dependent care expenses. Contributions are tax-deductible, but unused funds must be spent within the plan year or are forfeited (the “use-it-or-lose-it” rule).
For a similar account without the forfeiture rule, see HSA; for dependent care specifically, see dependent care FSA; for the 401(k) alternative, see retirement accounts.
How it works
During annual open enrollment, your employer offers a Flexible Spending Account. You decide how much to contribute for the year (up to $3,300 for medical FSA, variable for dependent care). This amount is deducted pre-tax from each paycheck.
Throughout the year, you submit medical receipts for reimbursement (copays, prescriptions, dental, vision, etc.). You receive the reimbursement from your FSA account. When the year ends, you submit final claims for any remaining balance.
The critical rule: unused money is forfeited. If you contribute $3,300 and spend only $2,000, the remaining $1,300 is gone.
Advantages
Tax savings. Every dollar spent reduces taxable income. If you are in a 24% tax bracket and use $3,300 in medical expenses, you save $792 in taxes.
Predictability. If you know you will have medical expenses (prescriptions, annual dental cleaning, copays), contributing to an FSA is efficient.
Disadvantages
Use-it-or-lose-it. This is the major downside. If you overestimate expenses, you forfeit the overage.
Not invested. Unlike an HSA, FSA funds do not earn interest or grow. The balance sits in cash (or a low-yield account).
Plan-dependent. You can use the FSA only through your employer’s plan. If you change jobs, you have until the end of the year to spend your balance; then it is forfeited.
Inflexibility. Once you elect an amount, you cannot easily change it mid-year unless you have a qualified life event (marriage, birth, change in dependent status).
Estimating the right contribution
The strategy is to contribute enough to cover expected expenses while not over-estimating:
- Identify recurring expenses. Prescriptions, annual dental cleaning, eye exams, copays for monthly doctor visits.
- Add a buffer. Unexpected medical expenses happen (injury, infection, illness).
- Be conservative. It is better to under-contribute and pay out-of-pocket for a few dollars than over-contribute and forfeit.
Example: you expect prescriptions ($400/year), dental cleaning ($200/year), copays ($600/year), and add a buffer ($200). You contribute $1,400. This is safer than contributing $3,300 and hoping to spend it all.
The grace period and carryover
Some plans offer a grace period (usually 2.5 months after the plan year ends) or allow a limited carryover ($610 in 2024). These rules reduce the sting of forfeiture. Check your plan’s specific rules during open enrollment.
FSA vs. HSA
| Feature | FSA | HSA |
|---|---|---|
| Eligibility | Employer offer (any health plan) | HDHP required |
| Annual limit | $3,300 | $4,150 |
| Investment | No | Yes |
| Use-it-or-lose-it | Yes | No |
| Carryover | Some plans allow $610 carryover | Full balance rolls over |
| Portability | Not portable (tied to employer) | Fully portable |
| Access age | During employment | Lifetime (even post-retirement) |
If you have the choice, HSA is superior due to investment potential and no forfeiture. But if your employer offers FSA and you cannot estimate expenses accurately, you can simply contribute less or not participate.
Dependent care FSA
Separate from medical FSA, many employers offer a dependent care FSA for childcare or eldercare costs (see dependent care FSA).
See also
Closely related
- HSA — superior alternative without forfeiture
- Dependent care FSA — for childcare/eldercare expenses
- 401(k) plan — another pre-tax benefit
Wider context
- Tax-deductible expenses — FSA as tax savings
- Budgeting methods — estimating medical expenses
- Emergency fund — managing unexpected medical costs