What Is A Flexible Spending Account (FSA)?

What Is A Flexible Spending Account (fsa)?
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Whether you have out-of-pocket health care expenses or dependent care costs, you may want to take advantage of your employer’s flexible spending account. An FSA may differ from employer to employer but can save you money and cut your taxes. Before enrolling, you should get a thorough understanding of how your employer’s FSA plan works. That’s because setting aside too much money into an FSA may cost you more in the long run.

Here is what you need to know about an FSA.

What Is a Flexible Spending Account?

An FSA is a type of savings account that provides tax advantages. It can be a great tax savings tool to effectively pay for qualified out-of-pocket expenses, whether related to health care or dependent care. It’s an arrangement that allows you to stash away pretax dollars for yourself, spouse or dependents. You establish an FSA through your employer.

How an FSA Works

The account allows you to contribute money from your paycheck tax-free. In some cases, your employer may also contribute on your behalf, though that’s not required. Since contributions made to your FSA are not taxed by Uncle Sam, participation allows you to cut your tax bill and effectively save money on qualified expenses.

For example, let’s say your earnings for 2022 are $35,000 and you elected to contribute $4,000 to your FSA during the year. That $4,000 will not be subject to the usual federal income taxes of up to 12% for your particular tax bracket. Meanwhile, the FSA gives you buying power because it allows you to pay for out-of-pocket (after-tax) qualified expenses with those pretax (before-tax) dollars.

What Is the Difference Between a Dependent Care FSA and a Health Care FSA?

There are two types of FSAs: a health care FSA and a dependent care FSA.

A health care FSA is used solely for qualified health care costs, such as medical, dental, vision and other typical medical expenses. Qualified expenses may also include copayments and deductibles, but you cannot pay health insurance premiums with your FSA.

A dependent care FSA is similar to a health care FSA but can cover only qualified dependent care expenses. You may use your dependent care FSA only for expenses for any child under the age of 13 or older dependents who are physically incapable of caring for themselves.

Qualified expenses include preschool, nursery, before and after daycare, summer daycare and other dependent care-related expenses. If your employer offers both a dependent care FSA and health care FSA, you may choose to enroll in both.

What Are the 2022 Limits of an FSA?

The amount you contribute to your FSA depends on the type of account and your filing status.

For a health care FSA, you may contribute up to $2,850 for the 2022 calendar year, though your employer can elect to limit you to a lower contribution amount. The IRS limits the amount your employer can contribute to your FSA: Even if you don’t fund your FSA account, your employer can make a contribution of up to $500 annually. If you fund your FSA account, your employer legally can match your deposits dollar for dollar.

With a dependent care FSA, the rules are a little different. For 2022, single taxpayers and married joint filers can contribute up to $5,000, while those who are married and file separately can contribute up to $2,500 for the year.

What Are the Advantages of an FSA Account?

Contributing to an FSA has many advantages. The primary ones include:

  • Reducing your taxable income
  • Reducing your payroll taxes
  • Providing access to funds right away as needed

As an employee, one of the major benefits is that funding an FSA allows you to reduce the amount of taxes you might otherwise owe. Your contributions to your FSA are excluded from your gross income, which may result in a significant annual income tax savings.

An FSA also reduces the amount of payroll taxes you’re required to pay. Your earnings are subject to payroll taxes, which include Medicare and Social Security taxes up to certain limits:

  • For 2022, your first $147,000 earned is subject to a 6.2% Social Security tax.
  • Also, all of your earnings are subject to a 1.45% Medicare tax. For those who earn above $200,000 ($250,000 for married couples who file jointly), there’s an additional Medicare tax of 0.09% assessed on earnings that exceed the threshold.

For example, let’s say you earn $75,000 for the year and elect to contribute $5,000 into an FSA. You will save $382.50 ($5,000 x 0.062 + $5,000 x 0.0145) in payroll taxes since your FSA contributions are not subject to Medicare or Social Security taxes.

Another great advantage of an FSA is that the amount you pledge at the beginning of the year is made available immediately for use. For example, let’s say you decide to contribute $100 per month from your earnings into your health care FSA on January 1, 2023. Then, let’s say on January 15 you incur dental expenses for uninsured, qualified medical expenses of $1,000. You can use your FSA to pay the full amount, even if you’ve contributed only $100 into your FSA.

What Are the Disadvantages of an FSA Account?

You must be careful and think ahead before contributing to an FSA, because there’s one major disadvantage you need to consider carefully: If you contribute too much into an FSA, you may forfeit your FSA funds at year-end.

Before deciding how much to contribute, take time out and project your qualified out-of-pocket health care and dependent care costs for the plan year. You may want to review the amounts paid in the previous year to gauge just how much to contribute to your FSA plan.

How Long Do You Have To Use Your FSA Account?

The time limit on using your FSA funds depends on your employer.

Typically, you are required to use your FSA funds before the end of the plan year. However, your employer may elect one of two options: a carryover feature or a 2.5-month grace period.

With a carryover, up to $570 in unused funds from 2022 could be rolled over to 2023. The amount you carry over does not reduce the amount you may contribute in the new year.

Or, an employer may opt to allow you to use your FSA funds for an additional 2.5-month grace period after the expiration of the plan year. In most cases, you will have until March 15 of the following year, if your FSA plan follows a calendar year.

How To Submit Your Payment Request for an FSA Expense

You can request payment for your qualified expenses by submitting a claim to your employer’s FSA administrator. Generally, you will need to provide proof, which may include an itemized receipt or proof of payment. Your payment receipt should include your cost, provider’s name, type of service provided, the date and the type of service rendered.

Before submitting your claim request, you should check with your employer to determine what other information is required to submit a claim.

Bottom Line

Funding an FSA is a great way to pay for out-of-pocket health care or dependent care expenses while also paying less in taxes. It is important to understand your employer’s FSA plans before enrolling. You should do your research about your plan’s election amounts, forfeiture rules and the types of plans that are available to you.

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