With open enrollment season, comes a whole different set of questions from both new and old clients. The Flexible Spending Account (FSA) is the source for many of those questions.
Flexible spending accounts can only be accessed via your employer, if your company offers one. For those of you that do have the option of utilizing an FSA, let’s review how it works.
And, before we get started, if you’re seeking information on Health Savings Accounts (HSAs), these are not the same as FSAs, so check out our HSA guide here.
What is an FSA (Flexible Spending Account)?
An FSA is a tax advantaged way to pay additional out-of-pocket medical expenses incurred each year.
An FSA must be sponsored by your employer – there is no other way to access this benefit if not offered by your employer.
Contributions to an FSA are tax-deductible, so setting money aside in an FSA reduces your taxable income in that year. Those contributions can then be used on any “qualified medical expenses”, which is defined broadly to include items such as doctor copays, contact lenses, and prescription medicines. Using the funds to make qualified purchases does not trigger any tax, so you’re effectively able to set this portion of your income away without ever incurring tax.
How much can be contributed to a FSA each year?
The maximum that can be contributed to an FSA in 2018 is $2,650. The FSA contribution limit has increased in 2019 though to $2,700. These are individual limits, so spouses may both make contributions of up to $2,700 in 2019 if both of their employers offer an FSA.
You’re typically required to select the amount that you will contribute for the upcoming year during the Open Enrollment period at the end of the previous year. Your contributions are then deducted from your regular paycheck. This amount typically cannot be adjusted again until the following year, unless something changes in your personal life (e.g. marriage, birth of a child, or start a new job).
What happens if I don’t spend the full amount in my FSA that year?
Funds in an FSA are not invested but rather held in cash. The FSA, unlike an HSA, is not intended to be a long-term investment vehicle.
Furthermore, the amount that can be rolled over to the following year is capped. The maximum annual rollover amount is limited to just $500.
So, if you contribute $1,000 and only spend $250, instead of having $750 leftover the following year, you’ll only have $500, and that extra $250 is simply lost. The takeaway is to make sure you withdraw any excess funds before the end of the year (the distribution will be taxable since you got an upfront tax deduction but there’s no penalty).
Do I need to keep receipts or other records for my FSA?
The most common setup for an FSA is that you are provided a special debit card to charge for any qualified medical expenses. You should consult with your employer or the provider of the FSA to see if there is a requirement to provide receipts, but typically that is not the case. It still could be worth documenting and keeping receipts though, as the IRS in theory might investigate the deduction to ensure the funds were spent appropriately. So, it’s always a best practice to save receipts when possible, although they’re unlikely to be needed.
The Flexible Spending Account is a great tax-advantaged benefit if offered to you by your employer. If you can roughly anticipate your minimum medical expenses for the year (items such as doctor copays or prescription medications), then you should certainly allocate a portion of your paycheck each year to an FSA and make those purchases out of that account. The FSA is a pure tax giveaway in that case.
Still have questions? Get in touch with a Visor tax advisor or leave a comment below and we’ll reply ASAP!
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