person checking on their FSA

Know the Basics: What is an FSA? And How Do I Set One Up?

Posted July 21, 2017 by Jacob Donelly in Benefits and Perks
What is a flexible spending account? We give you all the information so you know how to use one.

If you're looking into an FSA, you may want to find out what other fringe benefits prospective hires want.

Between all the jargon of HSAs and FSAs, you may have asked yourself — what is a flexible spending account, exactly?

A flexible spending account, or FSA, is an account eligible employees use to put pre-tax money into throughout the year. They then use that account to pay for certain health care out-of-pocket costs.

An employee elects how much money they want to save, then the money is deducted from that employee’s paycheck over the duration of the year. Because it is pre-tax income, there can be significant savings.

Unlike the HSA and the HRA, which are designated for higher out-of-pocket costs, FSAs are linked to most types of health insurance plans.

Before the Affordable Care Act (ACA) began, employers selected the maximum annual election. However, after the ACA took effect, the IRS set an annual FSA maximum limit of $2,500. Every year after, the IRS can modify it for cost of living. In 2017, the annual limit was $2,600.

What is an FSA?

Common Account Features of a Flexible Spending Account:

  • Can be used for deductibles, copays, medication, and other health care related out-of-pocket costs.
  • The employer owns the account — unlike with an HSAs — where the employee owns it.
  • All money deposited is untaxed.
  • For ease of use, most FSA accounts come with a debit card.
  • Employees can spend the money in the account before it’s fully funded.

How FSA Spending Works

If employees elect to receive the maximum of $2,600 at the beginning of the year, they'll immediately have access to that amount of money to cover health care costs. In the event that they need to spend it all in January, they can. That's because the company owns the account and is fronting employees the money. Each time money is withheld, the company gets repaid a little more.

Fringe benefits like FSAs can be confusing, but they don't have to be.

Get Your Guide

Employers should note that the company owns the money and liability. For example, say an employee has to pay $50 every pay check to cover her FSA. She uses the entire FSA by March, then leaves in June. By this logic, she would have only paid half of the total value of the FSA. Unless the FSA plan documents specifically state otherwise, the company loses.

Companies cannot take the remaining balance out of the employee’s last paycheck. Similarly, the FSA has an element of "use it or lose it" associated with it. Unlike an HSA, which the employee owns and is money in their own bank account, the amounts in FSAs are forfeitable.

Companies are permitted to include a carryover provision or a grace period for their FSAs. The carryover provisions permit employees to carryover up to $500 in unused FSA amounts from the previous calendar year.

The FSA has an element of "use it or lose it" associated with it

Employers also have the option to include a grace period of up to two and a half months. Regardless of what the employer chooses, the remaining balances in FSAs will be profit for the company.

Advantages and Disadvantages of an FSA

The disadvantages and advantages of an FSA are typically opposite for employees and employers.

Once the plan starts, all the money for the year is available to the employee. This is obviously an advantage because if employees need access to all the money on the first day of the plan, it's all available. However, if the employee were to use the money on the 1st and then quit on the 2nd, the employee wouldn’t have to pay into the plan as well. Naturally, this is a serious disadvantage for the employer because they would have to front the entire bill.

On the other hand, an advantage for the employer is that any money left over—after the $500 rollover—can be added to the company’s bottom line. It is pre-tax money the company set aside, which can increase profitability. This is a disadvantage for employees because they had the money for the FSA withdrawn from their paychecks, resulting in them funding the entire FSA.

However, both employers and employees benefit from the fact that FSAs are pre-tax. Employees can save money on their taxes by using an FSA. For employers, the cost of managing one of these accounts is relatively insignificant. It can also be an added perk when recruiting new employees.

How to Set Up an FSA

While setting up an FSA doesn’t require any outside organizations, it can be helpful to have a Third Party Administrator (TPA) who knows the rules of FSAs in and out. Once you identify who you want to work with, you’ll need to then determine the following:

  • How much money will you offer? While $2,600 is the maximum, you can set the maximum to lower.
  • Will there be any grace period? You can offer up to 2.5 months. Or, instead, will you permit carryovers?
  • What record keeping will you do? If you are issuing a debit card to your employees, makes sure to get receipts of all the transactions to ensure they used the funds for medical related expenses.

The TPA will manage all the claims, provide the summary plan, and manage enrollment. If you're finding someone through referral, check that they have a good reputation and a fast response time.

Justworks can help you find the right FSA plan for your company. Justworks can help deduct the employee’s contribution to the FSA while processing payroll.

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, legal or tax advice. If you have any legal or tax questions regarding this content or related issues, then you should consult with your professional legal or tax advisor.