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VIDEO: Captain Contributor Explains How FSAs Work

Understanding How FSAs Work

A Flexible Spending Account, or FSA, is a great way to save on taxes and set aside money for health and childcare expenses.

The basics of an FSA are pretty simple. Each pay day, you set aside funds before taxes are taken out to help pay for out-of-pocket expenses. You can’t spend the money on just anything, though. There are several different kinds of FSAs, and they each have their own rules.

Health FSA

First is the Health FSA, which is used to pay for healthcare expenses that insurance doesn’t cover. You can pay your co-pays, deductibles, prescriptions and other treatments. You can also use it for vision and dental work, and even for some supplies like bandages. A complete list of eligible expenses is available from the IRS. You can also ask your benefits representative for more information.

Limited Purpose Flexible Spending Account (LPFSA)

Another health related FSA is the Limited Purpose FSA (LPFSA). An LPFSA can only be used for eligible vision and dental expenses. The unique thing about a Limited Purpose FSA is that you must have an HSA to participate. With both accounts, you can maximize your tax and savings benefits.

Dependent Care FSA

And finally, another common type of FSA is not health related at all. It’s called a Dependent Care FSA, Dependent Care Assistance Plan, or DCAP for short. A DCAP is used for daycare, elderly or disabled dependent care, or for before and after school care. Dependents include children up to age 13 or relatives who are incapable of self-care.

There are limits on how much money you can put into an FSA set by the IRS. Check with your benefits representative to find out about annual contribution limits.

Flexible Spending Account Terminology

One important thing to keep in mind when deciding how much money to set aside is how your employer’s plan handles leftover funds at the end of the year. All DCAP accounts are "Use it or Lose it." Health FSAs, however, can be handled in one of three ways: Use it or Lose it, Carryover, or Grace Period:

  • Use it or Lose it: All FSA funds must be spent by the end of the plan year or you lose them 
  • Carryover: Any unused funds, up to $610, can be carried over from one plan year to the next
  • Grace Period: Participants get up to 2 ½ months after the end of the plan year to use any leftover funds

One great thing about an FSA is that even though the money is taken from your paycheck throughout the year, the entire amount is available on the first day of your plan year. For instance, if you have a big expense in January, you can spend the entire annual amount you have set aside for the year even though your contributions haven’t built up yet.

Understanding how FSAs work helps you get the most out of your tax savings.