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What Is a Flexible Spending Account (FSA) – Rules & Eligible Expenses


Rising health care costs have spurred constantly changing efforts to help Americans afford medical care. One benefit growing in popularity is the flexible spending account (FSA), which goes above and beyond your health insurance policy to help you pay for out-of-pocket medical costs.

If your employer offers an FSA, here’s everything you need to know about enrolling in and using the account.

What Is a Flexible Spending Account?

Flexible spending accounts, also known as “cafeteria” or Section 125 plans, are employer-sponsored tax-advantaged plans that reimburse employees for qualifying medical or dependent care expenses.

You can use an FSA to pay for personal or family costs ranging from medical and dental care to group term life insurance to dependent care. Some company FSA plans even cover employees’ travel expenses to get to and from work.

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The IRS established FSAs in 1978 and has amended the provisions over the years. According to a survey by health and retirement account management company WageWorks, 33 million workers use health care FSAs to cover out-of-pocket medical expenses like health insurance copays and deductibles.

How Does an FSA Work?

You sign up for an FSA as an employment benefit with an employer, and contributions come out of your paycheck pretax, similar to a 401(k) plan. Employers also typically make a contribution, either periodically or as a lump sum at the beginning of the plan year.

You can contribute up to $2,750 annually in 2021, but you forfeit any funds you don’t use by the end of the year. Any employer can set a lower contribution limit.

Any amount you contribute to an FSA in a year reduces your taxable income, as it’s not taxed as part of your wages. So, if your annual income tax rate is 25%, contributing to an FSA will give a tax savings of $25 for every $100 you put into the account.

How to Enroll

If your employer offers one, you can enroll in your company’s FSA when you begin work, after a period your employer specifies, or during a set enrollment period the employer sets, usually at the end of the year. Speak with your human resources department to learn more about your options and eligibility.

You determine how much to contribute from each paycheck when you enroll.

Similar to enrolling in group health insurance, you can’t make changes to your FSA enrollment settings unless you experience a major life change, such as a birth, death, adoption, marriage, or divorce in the family, or a change in your health insurance coverage.*

Consider your family’s typical annual costs for care — and any changes you expect in the coming year — to determine how much you’ll likely need to set aside throughout the year.

How to Use FSA Funds

To spend funds from your FSA, you either apply for reimbursement of qualifying expenses or receive a debit card from your employer that you can use to make payments upfront.

The funds in your FSA don’t roll over from year to year.* With FSAs, you forfeit anything you save but don’t spend back to your employer. Some companies, however, offer a grace period of around two and a half months, so you could use funds for a while into the following year.

This use-it-or-lose-it rule has limited the popularity of FSAs because most people have trouble accurately projecting any year’s medical expenses.

Most employers use the returned funds to cover the plan’s administration costs, but IRS regulations allow employers to alternatively use those funds to:

  • Give You a Bonus. The employer could contribute a bonus amount to your FSA so you’ll have to deduct less from your paycheck in the new year.
  • Increase Coverage. Forfeited funds can be pooled to increase the annual coverage amount for everyone participating in your employer’s FSA in the new year.
  • Pay You. Employers can distribute the funds to FSA participants as taxable income.

Read the details of your company’s FSA plan to determine how your employer handles forfeited funds.

*Note: The Consolidated Appropriations Act, 2021, passed in late 2020 in response to the COVID-19 pandemic, allows employers to adjust their FSA plans to allow for unlimited carryovers of unused funds from 2020 to 2021 and from 2021 to 2022. Employers can also choose to allow employees to enroll or make plan changes at any time in 2021 without a qualifying event.

Eligibility Requirements to Set up an FSA

Only your employer can set up and administer an FSA under the IRS code, subject to guidelines including:

  • Requirements for availability of legal documentation for the plan
  • An employers’ fiduciary responsibility to provide the funds to participants when requested

FSA administration is complex, and errors, omissions, or noncompliance with the rules can be expensive. Privacy laws regarding medical record confidentiality complicate administration, so most employers outsource FSA administration to third-party companies like they do for insurance plans and 401(k) plans.

Types of FSA Accounts

Your employer can decide whether to set up an FSA that covers health care expenses, child care expenses, or both. If your company’s program includes both, you can enroll in either or both FSAs through separate enrollments and separate payroll deductions for each.

The two are similar in some ways but differ in their purpose, contribution limits, and qualifying expenses.

Health Care FSA

  • Purpose: A health care FSA limits coverage to medical and health care expenses your health insurance doesn’t cover — usually deductibles, copayments, and coinsurance.
  • Annual Contribution Limit: $2,750 in 2021. Amounts adjust each year with inflation.
  • Immediate Fund Availability: The full amount you agree to contribute to an FSA in the coming year is available to you on the first day of the year. For example, if you agree to contribute $2,400 in the coming year, the full $2,400 is available to you on January 1, even though you’ll pay the amount in increments of $200 per month for the next 12 months.
  • Eligible Expenses: The plans are intended to generally cover your out-of-pocket medical, dental, vision, and pharmacy expenses, including over-the-counter medication and menstrual products, which were added in 2020.
  • Administration: Your employer might issue you a debit card you can use to pay for eligible expenses. Some plans require itemized receipts for debit card purchases. Some don’t include debit cards at all and instead require itemized applications for reimbursement.

Dependent Care FSA

  • Purpose: This type of FSA covers tax-deductible day care expenses for your dependent children under age 13, an older person you claim as a dependent on your tax return, or children or adults of any age who require care because of physical or mental limitations.
  • Annual Contribution Limit: You can contribute up to $5,000 per household — $5,000 if you’re an individual or part of a married couple who files a joint tax return, or $2,500 if you’re married but file separately. Your employer can contribute beyond that limit, but you have to claim anything above the limit as income on your tax return.
  • Limited Fund Availability: Unlike the health care FSA, a dependent care FSA is not prefunded. You only have access to funds as you pay them in. For example, if you contribute $400 each month, you can get only $400 in eligible costs reimbursed in January, even if your actual costs are higher that month.
  • Eligible Expenses: Eligible dependent-care expenses are generally those you pay so you can keep working — not any expenses the dependent incurs. Those could include the cost of a babysitter or day care while you work, but not during other times. Nursery school or preschool costs qualify, but K-12 tuition does not.
  • Administration: Most dependent care FSAs work by reimbursing you for expenses, rather than paying directly to the provider or giving you a debit card.
  • Coordinating With Federal and State Tax Credits: You may be eligible for the child and dependent care tax credit to offset some of your costs. You can pay for child or dependent care with an FSA and still claim relevant tax credits, but consult with an accountant to avoid claiming any benefit incorrectly.

What You Can Pay For With an FSA

Copays and medications aren’t the only things you can pay for with an FSA. As you estimate your health care costs for the upcoming year, keep in mind these products and services you can purchase with a flexible spending account:

  • Sunscreen
  • Sunglasses
  • Lip balm
  • Vasectomy
  • Lactation costs
  • Some fertility services (for example, fertility tracking using solutions like Mira)
  • Pregnancy tests
  • Birth control
  • Abortion
  • Acupuncture
  • Chiropractor visits
  • Menstrual cramp relief medication, including over-the-counter products
  • Tampons, pads, liners, and other menstrual products
  • Condoms
  • STI test kits
  • First aid kits and products
  • Transportation to medical appointments

See a full list of eligible expenses according to the IRS.


A health savings account (HSA) through a company like Lively is similar to a flexible spending account. An HSA is a tax-advantaged account you can use to cover out-of-pocket medical expenses.

An HSA serves a similar purpose to an FSA, but differs in a few major ways:

  • Who Can Establish a Plan. Anyone insured under a high-deductible health insurance plan can set up an HSA. You don’t have to rely on an employer’s plan.
  • Balance Rollover. Anything you contribute to an HSA remains in the account without a time limit, which means funds left over at the end of a year carry over into the following year. No balance limit exists.
  • Withdrawal. Like an FSA, you can use HSA funds to cover qualifying medical expenses without paying any taxes or penalties. With an HSA, you can also withdraw funds early if you need them, but you’ll pay taxes on it as income plus a 10% penalty fee.
  • Investment. Funds in an HSA can be invested in the market, similar to a retirement or college savings account.
  • Annual Contribution. Maximum annual contribution amounts for an HSA in 2021 are $3,600 for individuals and $7,200 for married couples filing jointly. Anyone over age 55 can contribute an additional $1,000 per year.

In most cases, you can’t enroll in both an HSA and FSA. However, some exceptions exist, as long as having both accounts doesn’t let you double dip. For example, if one plan only covers vision and dental, you could enroll in another to cover medical care.

If your employer offers both plans, the plan administrator should explain the rules governing the accounts to you.

You might prefer to open an HSA if:

  • You Have No FSA Available. If your employer doesn’t offer an FSA, you may benefit from opening an HSA to build a stockpile of tax-free funds to cover future medical care.
  • You Have Unpredictable Health Care Costs. An FSA is challenging if you can’t closely project the coming year’s expenses. An HSA lets you keep and use funds in the account anytime.
  • You Plan to Change Jobs. You forfeit unused funds in your FSA to your employer if you change or lose your job. HSA funds are portable and remain yours regardless of your employment status.

You might prefer to open an FSA if:

  • You’re Older Than 65. After that age, you can’t use an HSA to cover health insurance premiums, but you can still use an FSA.
  • You Don’t Have Health Insurance. You have to be covered under a high-deductible health plan to open an HSA, but you can participate in an FSA without any insurance coverage.

Final Word

Health care costs continue to rise in the United States, and any steps you can take to reduce the amount of money you put toward health care are usually worthwhile.

Tax-advantaged flexible spending accounts and health savings accounts let you use pretax dollars to pay for out-of-pocket medical, vision, dental, and in some cases dependent care costs. Funneling your health care funds through these accounts reduces the amount of money that comes out of your pocket.

When employers offer an FSA, they typically include a fixed upfront deposit, so you could get free money to help with health care or dependent care costs. You’ll benefit from contributing to an FSA from your paycheck if you can closely project a given year’s costs — if not, you might forfeit the funds.

If you have the option to open an HSA or FSA, consider your family’s circumstances and your expected health care costs to determine which is the best fit for you.

Dana Sitar has been writing and editing since 2011, covering personal finance, careers and digital media. Say hi and follow her on Twitter @danasitar.