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How do FSAs work? Understanding FSA programs

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Rising healthcare costs have led to innovative new ways of managing expenses. Flexible Spending Accounts (FSAs) have emerged as one solution. FSA programs can be a good fit for many employee health benefit programs, but before being able to decide, you may have some questions – for example, how do FSAs work? Understanding the ins and outs of these programs can help you and your employees make the most of them.

Flexible Spending Account vs. Health Savings Account

An FSA is a type of savings account that lets people pay for certain out-of-pocket medical expenses using tax-free dollars. An HSA is another type of savings account that lets people contribute tax-free dollars that can then be used to pay for qualified medical expenses.

FSAs might sound a lot like Health Savings Accounts (HSAs), but there are some key distinctions.

Typical Rules FSA HSA
Ownership Funds Owned by Employer Funds Owned by Employee

 

Savings Accumulation Timeframe Use or Lose Within Designated Timeframe Accumulate Savings Over Time, Can Be Used in Retirement
Portability Not Portable – May Lose Upon Job Change Portable

 

Eligible Health Plans Any Employer-Sponsored Health Plan Only for Use with High Deductible Health Plans

 

An FSA is an employee benefit set up by the employer, and the FSA belongs to the employer. An HSA, on the other hand, is owned by the individual, not the employer. This also means that HSAs are portable, whereas FSAs are not. If an employee with an FSA changes jobs, they can lose their funds.

People with FSAs can also lose their funds if they don’t use them. Although a limited amount of unused funds may carry over to the next year, the rest of the money will be lost if it is not used in the timeframe allowed. HSAs, on the other hand, never expire. In fact, money saved during a person’s working years can be used during retirement.

Another difference is that HSAs are designed specifically for people in high-deductible health plans. People who are not currently enrolled in a high-deductible health plan cannot make contributions to their HSA, although they still keep ownership of the funds and use the money for qualified expenses. An FSA can be used in conjunction with any employer-sponsored health plan.

The contribution limits can also be different. These limits are set by the IRS and are updated annually.

Flexible Health Spending Account Rules

In 2022, the FSA contribution limit is $2,850. The employee can contribute up to this amount, and none of this money is taxed. Money is often contributed via payroll deductions.

According to Healthcare.gov, if any money is left at the end of the year, the employee may have two and a half additional months to spend the money, or up to $570 can be carried over into the next year. However, this is up to the discretion of the employer, and employers do not have to provide the two-and-a-half-month grace period or the carryover option. Any money that is not used and does not carry over is lost.

The Consumer Financial Protection Bureau (CFPB) says that funds are often linked to a card. Presumably, this can make it easy to access the funds to spend on eligible medical expenses. However, if the card is stolen, the CFPB warns that the victim may not have the same rights to get the money back that they would with a stolen bank or credit union debit card. It is therefore very important to guard the FSA card carefully.

Eligible Medical Expenses

FSA funds can be used on qualified healthcare expenses. These expenses can be for the employee, the employee’s spouse and the employee’s children or other dependents.

Expenses that are typically allowed include (but at not limited to):

  • Insurance copays and deductibles
  • Certain prescription drugs
  • Medical devices
  • Dental care
  • Corrective contact lenses or glasses
  • Eye exams
  • Smoking cessation programs
  • Weight loss programs for medical reasons
  • Therapy

Certain expenses are not allowed. Ineligible expenses include cosmetic surgery, childcare, controlled substances that are illegal under federal law, funeral expenses, nutritional supplements.

For a more complete list of eligible and ineligible FSA expenses, see the IRS Publication 502.

Dependent Care FSA

In addition to Health Care FSAs, employers can also choose to offer Dependent Care FSAs. This is a separate type of FSA account with somewhat different rules.

Dependent Care FSAs can be used to pay for the care of a dependent child or dependent adult. According to Investopedia, people with Dependent Care FSAs will need to pay for the expenses out of pocket and then file a claim for reimbursement. As with Health Care FSAs, employees can fund the account using pre-tax dollars, but the annual contribution amount is limited. Not all care-related expenses are allowed. The money can only be used to cover services that are necessary in order for the employee or their spouse to work and earn an income. This can include things like in-home care, after-school care and summer day camps, but it does not include things like education costs, overnight summer camps, food or housekeeping.

Managing FSA Sign Up

If you decide to offer FSAs to your employees, you need to manage enrollment. There are a few key things to keep in mind:

  • Education. Employees need to understand both the pros and cons of FSAs before they decide if they want to enroll. To avoid future conflicts, make sure employees understand that they may lose their funds if they leave the company or don’t use the funds by a certain time. Also help employees understand which expenses are and are not eligible.
  • Amounts. Employees need to decide how much to contribute. While some employees may want to contribute the maximum allowable amount, this might not be a good choice for all employees. An employee with significant healthcare expenses may benefit from contributing as much as possible, but an employee with fewer healthcare needs might end up with unused FSA funds that have to be forfeited.
  • Access. Employees need to be able to access their FSA funds. This can be done using a card. While this is convenient, warn employees to keep their cards safe or risk losing their money.
  • Reminders. Because FSA funds expire, it’s important to remind employees a couple of months before the expiration date. This gives them a chance to use their remaining funds on things like vision expenses and dental care. Without a reminder, employees may forget about their accounts and then be upset when they realize that they’ve lost their money.

Should You Offer FSAs?

FSAs can be a great way to help employees manage their healthcare expenses. FSAs can also provide tax benefits because the contributions use pre-tax dollars, and this can reduce the employee’s taxable income and tax burden.

Although FSA programs might not be right for everyone, these tax-advantaged savings accounts can be an important part of an employee benefits package.

Do you need help putting together a benefits package that will meet the needs of your workers? Higginbotham can help. Learn more.

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