Whether you are building a benefits program for the first time or have been thinking about ways to boost your offerings, you’ve likely come across a health Flexible Spending Account (FSA) as an option. That being said, you’re probably not an expert in FSAs just yet and could still use answers to some of your questions before taking any next steps.
In this article, we’ll answer common questions about FSAs like, “What is a flexible spending account?” Additionally, we’ll get into how they work, what they cost, what the funds can be used for, and compliance requirements. After reading this, you’ll be prepared to decide if offering an FSA to your employees makes sense for your company.
A health Flexible Spending Account (FSA), also called a flexible spending arrangement, is a pre-tax account employees put money into to pay for certain out-of-pocket healthcare costs. Employees choose the contribution amounts, which are deducted from their gross pay, reducing their taxable income for that year.
Employers may design their plans to allow them to make contributions to an employee’s FSA, as well but aren’t required to. We’ll discuss employer health FSA contributions in more detail in a bit.
Employees can sign up for a health Flexible Spending Account during open enrollment. At that time, they’ll decide the contribution amounts they want deducted from each paycheck through a voluntary salary reduction agreement. It’s important to note that once a worker selects a contribution amount, they can’t change it unless there is a qualifying event mid-year. These events include a change in marital status, number of dependents, or employment status.
As we already mentioned, you as the employer can also make contributions, but the total can’t be more than the IRS maximums set each year. For 2023, that amount is $3,050, up $200 from last year. If employees are married, their spouses can also put up to $3,050 in an FSA with their employer.
Employees can use the funds in the FSAs to pay for certain medical expenses, which we’ll get into in more detail about shortly.
To get reimbursed for eligible costs, employees submit a claim (through you as their employer) with proof of the medical expense. You’ll need to set up procedures for substantiating these claims. If you use a third-party administrator, they may have a system for automatically approving funds. Either way, the reimbursement amounts are also tax-free.
Both FSAs and HSAs are tax advantage plan types that allow employees to set aside money on a pre-tax basis to cover certain healthcare expenses. But there are key differences between them. For example, with an HSA, employees can only participate if they are enrolled in a qualifying high deductible health plan.
One other way the plans differ is that the contribution limits for HSAs are higher than the FSA limits. And, since HSA balances roll over from year to year, these accounts can be part of a longer term savings strategy.
Another difference is that with an HSA, employees can change their payroll deductions at any time; with a health Flexible Spending Account, employees must choose the amount they want to contribute at the beginning of the plan year; this can only be changed in the event of certain life events, which we just discussed.
While we’re focusing here on health FSAs, there is another type: a dependent care FSA. A dependent care FSA operates like a health FSA but it can only cover qualified dependent care expenses for a child under age 13 or older dependents who are physically incapable of caring for themselves. Allowable expenses include things like preschool and nursery school and daycare.
If you choose, you can decide to offer a health FSA and dependent care FSA and employees can enroll in both.
There is a long list of products and services FSAs can be used for that are listed in IRS Publication 502. These include prescriptions, eyeglasses, dental care, chiropractors, home care, and ambulance services. While employees can use the funds to pay deductibles and copayments; they can’t use their FSA accounts to pay health insurance premiums.
It’s important to note that, in addition to your employees, they can also use the funds in their FSAs to cover qualified expenses for their spouse, if they’re married, as well as their dependents that are claimed on their tax return. This is true regardless of the health insurance they’re enrolled in.
Unlike health savings accounts (HSAs), an unused FSA balance generally doesn’t roll over to the next year and is instead forfeited by the employee. That means the funds would revert back to you as the employer. There are two exceptions to this rule.
Whether you opt for either one of these options or not, it’s also a good idea to encourage workers to spend down their balance before the end of the year so they don’t risk losing it. Be sure to communicate to your team about the deadline for using the funds and what they can be used on.
While FSAs are a cost-effective option, you’ll still incur some expenses. These include:
While FSAs offer your employees important tax advantages and opportunities to use pre-tax dollars to pay for eligible health expenses, these accounts are also beneficial to your business. Some of the advantages you’ll realize if you add FSAs to your benefits package include:
As we touched on earlier, there are rules governing FSAs that you’ll need to follow. The most common guidelines to be aware of include:
It’s critical that you follow FSA rules and regulations or you risk fines. For example, if you don’t file a Form 5500, you may have to pay a Department of Labor fine of up to $2,400 a day plus IRS penalties.
As you can see from these common questions, there are a lot of things to consider when it comes to offering a health flexible spending account to your employees. To decide if adding an FSA to your package is the right choice for your business, it’s a good idea to closely evaluate the benefits and drawbacks.