Definition of Flexible Spending Account (FSA)

Flexible Spending Account

A flexible spending account (FSA) allows eligible employees to pay for qualified healthcare expenses by setting aside pre-tax money into a tax-free account via payroll deductions.

What is an FSA?

A flexible spending account (FSA) allows eligible employees to set aside pre-tax money into a tax-free account and use this money to pay for eligible medical (or dental or vision) expenses. The amount contributed is taken out of each paycheck.

There is also a form of an FSA called a dependent care FSA. This type of FSA allows people to use funds from the account to cover eligible child and adult care expenses. Some examples of where you can use the funds from a dependent care FSA include:

  • Daycare
  • Preschool
  • Summer camp

Some things to know about FSAs:

  • FSA funds do not have to be paid back to the employer if the employee is terminated or quits during the benefits plan year
  • The contribution limit in 2023 is $3,050 (up from $2,850 in 2022)
  • Employees can carry over up to $610 of unspent FSA money in 2023 (however, the exact amount employees can carry over per year depends on the employer and plan administrator)
  • If your employer allows you to rollover funds, you can still contribute the maximum amount to your account (e.g., if you can roll over $610 from the year before, you can still contribute the total $3,050 that year)

Why are flexible spending accounts important to small businesses and human resources managers?

Offering an FSA is a win-win for employers and employees. FSAs help reduce the tax burden for both parties and minimize out-of-pocket spending on workers’ healthcare items.

Moreover, if you’re a human resources manager, you’re likely looking for ways to appeal to prospective employees and attract top talent.

It’s essential to offer something around health and wellness because healthcare benefits consistently appeal to employees.

As a small business, you might not be able to offer the most robust health insurance or medical benefits. However, it’s essential to explore offering something around health and wellness. This is because healthcare benefits, in particular, consistently appeal to employees.

When looking at what employees want most, health insurance is almost always at the top of the list. In one report, 90% of respondents ranked healthcare as “extremely important.”

If your company can’t offer health insurance, an FSA might be a way to appeal to prospective candidates. It also signals that you care about your people’s overall health and well-being.

What is the history of flexible spending accounts?

In the late 1960s in the United States, employers started facing increased costs of employer-sponsored health benefits due to inflation and other factors. The health reimbursement arrangement (HRA) was created to combat these increased costs. This tool also acts as a health reimbursement account.

Employers started instituting annual deductibles and coinsurance on their health benefits plans. However, some excluded coverage for certain necessary medical expenses, such as:

  • Dental
  • Vision
  • Alternative medicine

While helpful in offsetting costs for employers, these changes almost doubled the expense for these items for employees on an after-tax basis. Put simply, employers were reaping most of the rewards of these tax benefits.

In response to this problem, the Internal Revenue Service created FSAs in the 1970s. The new program allowed workers to pay pre-tax dollars for medical and dependent care expenses that their employer-sponsored health plan didn’t cover. This put more power back into the hands of employees so they could get the care they needed for their particular needs. They could choose how much to contribute and what to spend the money on (as long as it was an eligible medical expense).

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Summary of the definition of a flexible spending account

A flexible spending account allows eligible employees to set aside pre-tax money via payroll deductions into a tax-free account. They can use this money to pay for eligible healthcare expenses. Both employers and employees receive tax savings from FSAs.

Some companies also offer dependent care FSAs to cover eligible child and adult care expenses.

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