A flexible spending account (or flexible spending arrangement) is a benefit offered by employers that allows employees to take money out of their pay before taxes, put it into an account, and then pay for some specific things with that before-tax money. Enrolling in these accounts can save you up to 30% a year on taxes on what you set aside, depending on your tax bracket.
There are different types of accounts based on their purpose but most have the same rules. The basic idea is that employees can contribute pre-tax dollars every year, and then use that amount on qualified expenses during that year, thereby saving money on taxes. The accounts have annual contribution limits imposed by the IRS and may have grace periods (check your plan rules) that extend past year end. At the end of the year or the end of the grace period, you lose any money left over. That’s right – money you contribute but don’t use is NOT rolled over to next year. You lose it. So it’s very important to plan carefully and not put more money in the accounts than you think you’ll spend during the year.
During the plan year, you can change the amount of money being withheld for FSA contributions – but only within a 31-day window following a “qualifying event” or “change of status” as defined by the IRS. That could be something like a change in marital status, a change in the number of dependents, or change in the cost of dependent care (like daycare). In these cases you may want to re-consider how much you’re putting into an FSA, but you’ve only got about a month to do it.
Flexible Spending Accounts usually have a specific purpose; here are some of the more common ones.
A Health Care Flexible Spending Account- HCFSA (full purpose) allows you to be reimbursed for eligible medical, dental and vision expenses that aren’t paid for by insurance or otherwise reimbursed. Some expenses these might cover include office visit co-payments, prescription medications, medical equipment, orthodontia, glasses and contact lenses. You can receive reimbursement as you incur expenses up to the amount you have chosen to contribute for the year, even if you haven’t yet contributed that much in the year. For example you could be reimbursed for $2,000 in expenses in a year if you’ve chosen to contribute $3,000 even if you’ve only contributed $500 so far. This type of account can be used in conjunction with most health plans except for high deductible health plans that offer a Health Savings Account (HSA). Check with your employer about grace periods and rollover rules.
A Limited Dental/Vision Flexible Spending Account has all the same rules and features as an HCFSA except you can only be reimbursed for eligible dental and vision expenses that are not reimbursed or paid by another source. This account can be used with high deductible health plans and an HSA.
A Dependent Care Flexible Spending Account (DCFSA) allows you to set aside money on a pre-tax basis for eligible daycare expenses associated with caring for your children under the age of 13, or elderly or disabled dependents who you claim as tax dependents. Child and adult daycare, babysitters or nannies used while working, before or after school care and summer day camp are all expenses this type of account would cover. It differs from the HCFSA in that you can only claim reimbursement for the current amount in your account and not your full annual election. It’s important to note that if you use a DCFSA, you can’t claim the dependent tax credit on your federal taxes for the same expenses.
Transportation Spending Accounts are the exception to the use-it-or-lose-it and enrollment rules that applies to most FSA’s. They allow employees to pay for work-related transportation costs such as public transit (bus, van, rail, ferry) and qualified parking expenses with before tax dollars. You can only claim reimbursement for the current amount in each of these accounts at the time of your expenditure. It differs from an FSA in that you can start or stop your contribution at any time and your funds do not expire unless you leave your company.