When it comes to health insurance, there is lots of jargon and plenty of acronyms. Many people have heard of FSAs but may not actually know — what is a flexible spending account, exactly?
Whether you’re an employer trying to understand the benefits you’re offering to your team, or an employee trying to determine what benefits will suit your needs, it’s worth exploring what an FSA brings to the table. Let’s dive in.
Can't keep up with all the health insurance terms out there?
What is an FSA?
A flexible spending account, or FSA, is an account eligible employees allocate pre-tax money to throughout the year. They then use funds in that account to pay for certain out-of-pocket health care costs.
Employees can use FSA funds to pay for certain out-of-pocket health care costs.
An employee elects how much money they want to allocate, 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 when using FSA funds over your checking account.
Unlike the HSA and the HRA, which are designated for higher out-of-pocket costs (typically, high-deductible health plans), FSAs are available for use with most types of health insurance plans.
Before the Affordable Care Act (ACA) was enacted, employers selected the maximum annual election. However, after the ACA took effect, the IRS set an annual FSA maximum limit of $2,500. Moving forward, the IRS can modify that limit every year to adjust for cost of living. In 2019, the annual limit was raised to $2,700.
Common Features of an FSA
- Funds can be used for deductibles, copays, medication, and other health care related out-of-pocket costs.
- The employer owns the account — if you leave the company, you can’t take the account with you.
- 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 $2,700 at the beginning of the year, they'll immediately have access to that full 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.
Employees can save on their taxes by contributing to an FSA and reducing their taxable income.
Employers should note that the company owns not only the money, but also the liability. For example, say an employee has to pay $50 every paycheck to cover their FSA. They might use the entire amount by March, then resign in June. The employee would only have paid half of the total value of the FSA, meaning that the company pays out the rest. Companies cannot take the remaining balance out of the employee’s last paycheck.
On the employee side, the FSA has a risk element of "use it or lose it" associated with it. Unlike an HSA, which the employee owns, the amounts in FSAs are forfeitable. If you don’t use the full amount you’ve elected to contribute by the end of the calendar year, the rest is forfeited and goes back to the employer.
That said, 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. A grace period allows employers to include a period of up to two and a half months when the employee can continue to use FSA funds for health care services during that time. Regardless of what the employer chooses, any remaining balances in FSAs at the end of that period will be profit for the company.
FSA Advantages and Disadvantages
On the employee side, once the plan starts, all the money for the year is available for use. 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. Naturally, this is a disadvantage for the employer because they would have to foot the bill.
On the other hand, an advantage for the employer is that any money left over—after the $500 rollover, if applicable—can be added to the company’s bottom line for use on plan-related expenses. This is a disadvantage for employees because they had the money for the FSA withdrawn from their paychecks, resulting in them funding the FSA and not being able to use it all for their out-of-pocket health care costs.
However, overall, both employers and employees can benefit from FSAs. Employees can save on their taxes by contributing to an FSA and reducing their taxable income. And employers can add this benefit, at relatively low cost, to help with recruiting and retaining employees.
How to Set Up an FSA
For employers, setting up an FSA doesn’t require any outside organizations, but it can be helpful to work with a Third Party Administrator (TPA) that 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? As an employer, you can set the maximum an employee can contribute to an FSA as long as the amount does not exceed the $2700 limit set by the IRS.
- Will there be any grace period or carryovers? You can offer a grace period of up to 2.5 months. Or, instead, will you permit carryovers?
If you offer your employees access to health insurance through Justworks, you can offer FSAs through Justworks, too. You can manage this benefit within the Justworks platform, and employees can easily access their FSA as well. Once they set up their contributions, Justworks will simply 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.