An FSA is a tax-advantaged savings account for health and dependent care costs

A Flexible Spending Account (FSA) is an employer-sponsored account that lets you set aside pre-tax money for certain out-of-pocket medical expenses or dependent care costs. Money you put into an FSA reduces your taxable income for the year, which means you pay less in federal income tax and payroll taxes on that amount.

FSAs come in two types: a medical FSA (sometimes called a healthcare FSA) and a dependent care FSA. A medical FSA covers things like copays, deductibles, prescription medications, and certain medical equipment. A dependent care FSA covers costs for childcare, adult daycare, or summer camp — expenses you need to pay so you can work.

The account is funded through payroll deductions, meaning your employer takes the money directly from your paycheck before taxes are calculated. You then use a debit card or submit receipts to withdraw money from the account to pay for covered expenses.

Key Takeaways

  • FSA money comes from your own paycheck but reduces your taxable income, saving you money on taxes.
  • Medical FSAs cover copays, deductibles, prescriptions, and some medical equipment; dependent care FSAs cover childcare and adult daycare expenses.
  • You must enroll during your employer's open enrollment period, usually once per year, and the money is only available during that plan year.
  • Unused FSA money does not roll over to the next year — you lose it if you do not spend it, so you need to estimate carefully.
  • FSAs are separate from health insurance; you can have both at the same time.

How much you can contribute and when you can use it

The IRS sets a maximum contribution limit for FSAs each year. For medical FSAs, the limit changes annually — check with your employer or the IRS website for the current year's cap. Dependent care FSAs have a separate, lower limit. You choose how much to contribute during open enrollment, and that amount is divided into equal paycheck deductions throughout the year.

You can only change your FSA contribution during open enrollment, which is usually in the fall for a plan year that starts January 1. If you have a may have access to life event — such as the birth of a child, marriage, divorce, or loss of other health coverage — you may be able to change your contribution mid-year. Your employer's benefits department can tell you whether your situation qualifies.

Money in your FSA is available to use as soon as the plan year begins, even if you have not yet paid the full amount through payroll deductions. This means you can use the full annual amount you elected on January 1, even though you will not finish paying it in until December.

The "use it or lose it" rule and what happens to leftover money

FSA money does not carry over to the next year. If you contribute $2,500 to a medical FSA and only spend $1,800, the remaining $700 is forfeited — you cannot get it back as a refund or roll it into next year's account. This is called the "use it or lose it" rule, and it is one of the biggest drawbacks of FSAs.

Some employers offer a grace period of up to 2.5 months into the next plan year, during which you can still spend money from the previous year's FSA. Not all employers offer this, so check your plan documents. A few employers also offer a carryover option that lets you keep up to $610 (the amount changes yearly) to use in the next year, but this is less common.

Because of this rule, you need to estimate your expenses carefully. If you are unsure whether you will use the full amount, contribute a smaller sum. It is better to leave money on the table than to contribute too much and lose it.

FSA versus HSA: what homeowners should know

An HSA (Health Savings Account) is different from an FSA in important ways. HSAs roll over year to year — money you do not spend stays in the account and grows. HSAs also have lower contribution limits but offer more flexibility in what you can spend the money on as you get older. However, you can only open an HSA if you are enrolled in a high-deductible health plan, whereas FSAs work with any health insurance.

Some employers offer both an FSA and an HSA, but you cannot contribute to both in the same year if you have an HSA-may be able to access health plan. If your employer offers an HSA, compare the two before deciding which to fund. An HSA is usually better if you want money to accumulate over time; an FSA is better if you have predictable, near-term expenses you know you will use.

How to use FSA money to pay for expenses

When you enroll in an FSA, your employer gives you a debit card linked to the account. You can use this card at pharmacies, doctor's offices, and other providers that accept it. The card works like a regular debit card, and the charge comes directly from your FSA balance.

For expenses the debit card cannot cover, you pay out of pocket and then submit a claim to your FSA administrator with a receipt. The administrator reviews the receipt to confirm the expense is covered, and then reimburses you. This process usually takes one to two weeks. Keep all receipts for at least three years in case the administrator asks for proof.

Not all medical expenses are covered by an FSA. Expenses like health insurance premiums, long-term care, cosmetic procedures, and over-the-counter medications (without a prescription) are not covered. Your plan documents list what is and is not covered, so review them before you spend money.

FSA and taxes: why it saves you money

The main benefit of an FSA is the tax savings. If you contribute $2,500 to a medical FSA, that $2,500 is deducted from your gross income before federal income tax, Social Security tax, and Medicare tax are calculated. Depending on your tax bracket, this can save you $600 to $1,000 or more per year on taxes.

For example, if you earn $60,000 per year and contribute $2,500 to an FSA, you only pay income tax on $57,500. The money you save on taxes is real money in your pocket, even though you are spending it on medical or dependent care costs you would have paid anyway.

This tax advantage is why FSAs are worth considering even though you lose unused money. If you can predict your expenses with reasonable accuracy, the tax savings often outweigh the risk of forfeiture.

Frequently Asked Questions

Can I use my FSA to pay for my spouse's medical expenses?

Yes, you can use your medical FSA to pay for covered expenses for yourself, your spouse, and your dependents — anyone you claim on your tax return. The expenses must be for medical care, but the person receiving the care does not have to be on your health insurance plan.

What happens to my FSA if I leave my job?

You lose access to your FSA when you leave your employer. You have until the end of the plan year to submit claims for expenses you incurred while employed, but any unspent money is forfeited. Some employers let you continue coverage through COBRA, but this is rare for FSAs and usually not worth the cost.

Can I use my dependent care FSA to pay for summer camp?

Yes, if the camp is primarily for childcare while you work. Day camps and overnight camps that allow you to work may have access to. However, camps that are mainly educational or recreational, or overnight camps where you are not working, do not may have access to. Ask the camp provider or your FSA administrator if you are unsure.

Do I have to enroll in an FSA every year?

No. If you enrolled in a previous year and do nothing during open enrollment, your FSA ends and you lose any remaining balance. You must actively enroll each year if you want an FSA. Some employers auto-enroll employees, but this is uncommon — check with your benefits department.

Can I use my FSA to buy over-the-counter medications?

Not without a prescription. Over-the-counter medications like pain relievers, cold medicine, and allergy pills are covered only if your doctor writes a prescription for them. Insulin is an exception — you can buy it over the counter without a prescription and still use your FSA.