What is a Flexible Spending Account (FSA)?
Flexible Spending Account (FSA) is a health savings bank account that is opened as a requirement of employer- employee agreement and is used for building the surplus cash position for any emergency needs of the employee such as medical expenses or for any other purpose. The surplus is contributed by the individual or employee over the years of his regular earnings.
How does it Work?
The Flexible Spending Account allows deducting a specific amount from your regular earnings frequently. Such deduction lowers down the taxable income of the individual. Lower taxable income leads to a lower tax liability for the individual as the deduction is made from earnings before taxes.
The IRS provides a maximum limit on the contribution to be made to such account. As per the revised limits in 2020, the per-employee limit for medical expenses is $ 2750 as compared to $ 2700 in the calendar year 2019. In case the individual is married, the limit applies separately for the spouse through the spouse’s employer.
Further, the employer may also contribute to the FSA of the employee as per his discretion. However, such contribution by the employer is voluntary.
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Types of Flexible Spending Account
#1 – Dependent Care FSA
It is also called as “dependent care reimbursement account” (DCRA). This account is used only for the expenses of the dependent person. Expenses such as day-care, elderly care or preschool or any other expenses of dependent are allowed under such account.
#2 – Health Care FSA
The funds accumulated in such account can be used for expenses such as medical, vision or dental expenses or any other qualified expenses. Usage for non-qualified purpose is usually not allowed.
#3 – LPFSA
It stands for Limited Purpose Flexible Spending Account. It can be used along with a health saving account. The available funds are free to be used for dental or vision expenses or for any other purpose as notified.
#4 – PDFSA
It stands for Post Deductible Flexible Spending Account. The IRS allows a minimum deductible amount. These funds are used for section 213d medical expenses if the minimum deduction limit is achieved.
Limit and Grace Period of Flexible Spending Account
- Even if the account name is “flexible” spending, you are obliged to use the funds within the plan year itself. However, the employer may allow a grace period of up to 2.5 months over & above the normal tenure, to let you use the funds of the said account.
- On the other hand, the employer may allow you to carry forwards amount to the extent of $ 500 per annum in the next plan year. The employer will provide either of these options at his discretion.
- If the funds are not utilised within the plan year or the grace period, the balance pending amount is not refunded back to you. Thus, it would be best if you strategically thought over the amount of contribution to be made in FSA.
Flexible Spending Account Eligibility List
The IRS is very concerned about what includes in the term “medical care”. As per the definition of medical care, it should relate to diagnosis, mitigation or treatment or prevention of disease, cure, or for the care of any part or function of the body. The funds out of FSR is eligible to be spent for following purposes:
- Purchase of health care products over the counter
- Payments for doctors visit of expenses
- Payment for prescribed medical needs
- Dental expenses
- Vision expenses
- First aid supplies expenses
- Expenses for prescribed eyeglasses
- Urgent medical needs of the employee are taken care of.
- The amount contributed is provided as exemption from taxable income which lowers down the taxable income of the individual. Lower taxable income results in lower tax liability for the individual.
- Needs for dependent care or children care are also taken care of.
- The employee is saved from the stress of managing the expenses in case of medical emergencies.
- There is an expiry period for the amount deposited. If you do not use the funds within the said period, the hard-earned money is lost. However, the employer may provide an option for a grace period or carry forward of the amount.
- There is an upper cap of $ 2750 (for the calendar year 2020). In case the actual expenses are higher than the said amount, the employee needs to bear the remaining amount.
- Flexible savings accounts are linked to the employer. In case you leave the job, you cannot carry forward the benefits to the new employer.
- No deduction is allowed for actual spending of the amount.
This has been a guide to What is Flexible Spending Account & its Definition. Here we discuss its types, how it works, benefits and disadvantages. You can learn more about from the following articles –