What is a flexible spending account?

A flexible spending account, which is sometimes referred to as a flexible spending arrangement, is a dedicated savings account that’s designed to help workers save money on anticipated health care costs. FSAs let employees and/or employers set aside money to pay for expenses such as out-of-pocket medical costs the worker will incur throughout the year.

Because FSA contributions are deducted from an employee’s earnings, they aren’t subject to payroll or income taxes. Disbursements from an FSA must be used to reimburse employees for qualified expenses, which typically include costs for medical, dental or vision services. If the money isn’t used by the end of the plan year or the designated grace period, the employee forfeits the funds.

What kind of expenses are typically covered by an FSA?

FSAs are typically intended to cover health care-related expenses such as medical, dental and vision care. However, because FSAs provide tax savings to employees and employers, covered services are determined by the IRS rather than the employer or plan administrator. Reimbursable expenses include but aren’t limited to the following items and services:

• Prescription medications
• Certain OTC medications (with a physician’s prescription)
• Hearing aids and batteries
• Eye exams and eyeglasses
• Insulin and blood sugar test kits
• Medical supplies
• Equipment such as crutches or wheelchairs
• Diagnostic devices
• First aid kits
• Thermometers
• Co-pays and deductibles for medical services

Special types of FSAs, known as dependent-care flexible spending accounts, may be set up to accommodate expenses related to the care of children aged 12 and under or qualified adult dependents.

For more information on what can be reimbursed, employers may refer to the IRS’s list of FSA-eligible items.

What are a flexible spending account’s limitations?

FSAs only reimburse for items purchased during the plan’s coverage period, which is usually a calendar year. However, an employer may add a grace period of up to about 2-1/2 months, during which workers may use up the remaining plan funds.

Employees may not use FSA funds to stockpile supplies such as bandages or medications. FSAs only cover what can typically be used during the plan’s coverage term. Employees may not request reimbursement for items that have already been covered under another plan.

How do flexible spending accounts work?

Employees who want to join their employer’s FSA plan can do so during four enrollment periods:

• Within the first 30 days of employment
• When the employer opens a new FSA
• During the formal open enrollment period
• During qualifying life events such as marriage, divorce or the birth of a child

At the time of enrollment, participating employees must commit to a contribution amount up to the IRS’s current annual pretax maximum contribution of $2,750 or the maximum you set, which may be less than $2,750. Employers are not required to make contributions to an FSA, but they may choose to do so. Your contribution won’t affect what your worker can contribute, but it may be limited by current IRS regulations.

You’ll then deduct the appropriate amount from the employee’s paycheck, placing the money in the FSA, where it remains until the employee submits a reimbursement request.

Once the employee is enrolled, they may submit receipts for eligible expenses. You’ll reimburse the employee from the plan funds.

How do I set up an FSA for my employees?

For most SMBs, the best way to set up an FSA is to bring in a reputable third-party administrator. Although a company may administer its own plan, the changing legislation surrounding FSAs and the complexity of the required forms can present challenges to SMBs that don’t fully understand this type of account.

Even if your company knows how to set up an FSA, self-administered plans can create privacy concerns for employees. Employers who run their own plans have access to protected health information as requests for reimbursement come in. By bringing in a third-party administrator, you can protect the privacy of your employees and safeguard your company from any resulting HR issues.

Regardless of who administers the plan, employers still need to make several important decisions:

• The maximum contribution an employee may make in a calendar year
• Whether you’ll be contributing to the FSA as part of the benefits package and how much
• If you’ll allow a grace period and what it will be for purchases and reimbursements

The pros and cons of offering an FSA to employees

FSAs have advantages and disadvantages for both employees and businesses. By understanding the pros and cons of flexible spending accounts, you can help your HR staff and your employees make more informed decisions about plan participation.

Pros:

• FSAs can fit into a comprehensive benefits package that helps you recruit and retain employees.
• FSAs can lead to a reduction in the employer’s contribution to payroll taxes and FICA.
• FSAs can help you offset any increases in cost-sharing with employees.
• You can write off administrative costs associated with the plan

Cons:

• If an employee doesn’t use all the money they’ve put into the FSA, they risk losing it.
• You must comply with the Uniform Coverage Rule. That means that once the plan is in effect, employees are entitled to full reimbursement even if they haven’t yet made their full contribution.
• Employees may resign prior to completing their contribution, leaving the company responsible for the full reimbursement if it’s been used.

How has COVID-19 impacted FSA regulations?

Under the Taxpayer Certainty and Disaster Tax Relief Act of 2020, employers may adjust their plans to help their employees cope with the consequences of COVID-19. Adjustments to plans may include:

• Carrying over unused funds
• Extending the claims period
• Permitting midyear contribution changes

Most of these changes currently only affect plans for the 2020 and 2021 calendar years.

FAQ

What is the difference between an FSA and HSA?

Flexible spending accounts and health savings accounts are benefits that let employees set aside pretax dollars for specific purposes. FSA funds may be used for a wide array of health care-related expenses. HSAs are typically offered alongside high-deductible health insurance plans to help defray the cost of services received before the deductible has been met. Unlike FSAs, HSA plans may be rolled over at the end of the year, and they’re available to self-employed individuals.

There are several other notable differences between these two types of plans:

• HSAs are interest-bearing accounts and the interest is tax free, whereas FSAs don’t earn interest.
• HSAs may follow employees from one job to the next. An employee forfeits their FSA plan if they leave their employer.
• Employees enrolled in FSAs must commit to an annual contribution amount. Individuals enrolled in HSAs may change their contribution amount throughout the year.
• HSAs permit withdrawals with a penalty. FSAs do not permit withdrawals.

Can you offer an FSA without a medical plan?

Yes. An FSA is a stand-alone benefit that doesn’t need to be offered in conjunction with a health insurance plan.

Who cannot participate in an FSA?

Typically, the only eligibility requirement for participation in an FSA is to be an employee of a company that offers an FSA. If you are unemployed, are self-employed or have an employer that doesn’t offer a plan, you can’t participate in an FSA.