Flexible Spending Account:
Definition, Types, Uses & Benefits

A Flexible Spending Account (FSA), also known as a flexible spending arrangement, is an employer-sponsored tax-advantaged account that allows employees to set aside pre-tax dollars from their paycheck to pay for eligible out-of-pocket healthcare and dependent care expenses. FSAs were first established in 1978 through Section 134 of the Revenue Act and provide employees with the opportunity to reduce their taxable income while covering qualified medical costs.

The money contributed to an FSA is deducted before federal income tax, employment tax, and in most cases state taxes are applied. This means employees save an amount equal to the taxes they would have paid on the money set aside—typically around 30% on average based on combined federal, state, and FICA tax rates. FSAs are owned by the employer, not the employee, which distinguishes them from other health savings vehicles.

Related terms: Health Savings Account (HSA), Health Reimbursement Arrangement (HRA), cafeteria plan, Section 125 plan

There are four primary types of FSAs, each designed to cover different categories of expenses. The Healthcare FSA is the most common type and covers medical, dental, vision, hearing, and prescription expenses including deductibles, copayments, coinsurance, and over-the-counter medications. This general-purpose FSA can be used for thousands of eligible expenses.

The Limited Purpose FSA (LP-FSA) restricts eligible expenses to dental, vision, and preventive care only. This type is specifically designed to be compatible with Health Savings Accounts, allowing employees enrolled in an HSA to still benefit from an FSA for dental and vision costs. The Dependent Care FSA (DC-FSA) covers employment-related expenses for childcare and eldercare, including daycare, preschool, after-school programs, and senior care for dependents who are physically or mentally unable to care for themselves.

The Post-Deductible FSA is a less common option that can only be used for dental and vision expenses until the employee reaches their minimum annual deductible. After the deductible is met, the funds can be used for any qualified medical costs. This type is also HSA-compatible.

The IRS sets annual contribution limits for FSAs and adjusts them periodically for inflation. For Healthcare FSAs and Limited Purpose FSAs, the contribution limit for 2026 is $3,400 per employee per year. This represents a $100 increase from the 2025 limit of $3,300. The limit applies per person, meaning each spouse in a household may contribute up to the limit if both have access to an FSA through their respective employers.

For Dependent Care FSAs, the 2026 limit is $7,500 per household for married couples filing jointly or single parents, or $3,750 per parent if married and filing separately. According to the One Big Beautiful Bill Act (OBBBA), this limit increases from the previous $5,000 and $2,500 thresholds. Employers have the option to set lower contribution limits than the IRS maximum. Any carryover amounts do not reduce the participant's maximum FSA contribution for the next plan year.

Healthcare FSAs cover a wide range of medical, dental, and vision expenses that are not paid for by insurance. Eligible expenses include deductibles, copayments, coinsurance, prescription medications, acupuncture, ambulance services, bandages and first aid supplies, birth control, blood pressure monitors, chiropractic care, cholesterol test kits, COVID-19 personal protective equipment including hand sanitizers and masks, dental care and cleanings, diagnostic devices and services, eye exams, prescription eyeglasses and contact lenses, laser eye surgery, hospital services, immunizations, laboratory fees, medical testing devices, menstrual care products, over-the-counter pain relievers, nursing services, orthodontia including braces, hearing aids, crutches, motorized wheelchairs, and X-rays.

Effective January 1, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) made over-the-counter medicines allowable without a prescription or physician's note, and added menstrual care products as eligible expenses. Prior to this change, over-the-counter drugs required a prescription following the 2010 Patient Protection and Affordable Care Act. The IRS maintains the complete list of eligible expenses in Publication 502, which is updated regularly. Employers may limit what expenses their specific plan reimburses, so employees should contact their Human Resources office for plan-specific details.

Dependent Care FSAs cover employment-related expenses for care services that allow the account holder to work. Qualified expenses include childcare for children under age 13, nursery school, preschool, before-school and after-school care programs, day camp, and eldercare for dependents who are physically or mentally incapable of self-care. The dependent must be a tax dependent who lives with the caretaker for more than six months of the year.

Day care centers outside the home and household employees who provide care for qualifying dependents are eligible. Transportation to and from daycare provided by the care provider is often allowable with a letter of necessity. Overnight camps are not eligible expenses. To qualify for a Dependent Care FSA, the account holder and their spouse must both earn income, or the non-earning spouse must be disabled or a full-time student. If one spouse earns less than the annual limit, the benefit is limited to whatever that spouse earned.

The use-it-or-lose-it rule requires that FSA funds generally must be spent within the plan year or they are forfeited to the employer. This rule was established by the IRS in 1984 when the agency ruled that while FSAs were allowable, employees must elect a certain amount for the plan each year and any unused amounts would be forfeited at the end of the year. Money remaining in an FSA at the end of the coverage period can be applied to future plan administrative costs or equally allocated as taxable income among all plan participants.

Employers have the option to offer one of two deadline extensions to help employees avoid forfeiture, but not both simultaneously. The Grace Period allows employees up to 2.5 extra months after the end of the plan year to spend remaining FSA funds. The Carryover provision permits employees to roll over a limited amount of unused funds to the following plan year. As of 2026, the maximum carryover amount is $680 for Healthcare FSAs, increased from $660 in 2025. Not all employers offer these options, and some plans may have lower limits. The carryover amount does not reduce the participant's maximum FSA contribution for the next plan year.

For Dependent Care FSAs, the use-it-or-lose-it rule applies with no carryover option available. The coverage period ends either when the plan year ends or when coverage under the plan ends due to employment termination. Expenses are considered "incurred" when the service is performed, not when payment is made, and services must be performed during the plan participation period to qualify for reimbursement.

The run-out period is a specified time after the end of the plan year or following employment termination during which employees may continue to submit claims for expenses incurred during their coverage period. This is not a period when new expenses can be incurred, but rather allows time to gather documentation and submit claims before funds are forfeited. For example, if a plan has a 90-day run-out period, employees have 90 days from their termination date to submit expenses incurred before the termination date. The run-out period varies by employer and should be detailed in the plan's summary plan description.

Employees can access FSA funds through three primary methods. The FSA debit card allows participants to pay for qualified expenses directly at the point of sale at healthcare-related merchants including hospitals, vision and dental offices, doctor's offices, and hundreds of local retailers that accept Mastercard or Visa. Pharmacies and grocery stores that accept the debit card must disallow transactions at point of sale if participants attempt to pay for ineligible items.

Online bill pay through the FSA administrator's portal enables direct payment to healthcare providers. Direct reimbursement allows employees to pay out of pocket for eligible expenses and then submit claims with itemized receipts or Explanations of Benefits (EOBs) for reimbursement either by check or direct deposit if that feature is enabled. Credit card receipts, non-itemized cash register receipts, and canceled checks are not acceptable forms of documentation—itemized receipts or EOBs from healthcare providers or merchants are required.

For Healthcare FSAs, the employer must require employees to provide itemized receipts for all expenses charged to the debit card. The IRS allows employers to waive this requirement when an individual uses the debit card at a pharmacy or grocery store that complies with inventory information approval system (IIAS) procedures, or when the amount charged is a multiple of the employee's group health insurance plan co-pay.

Healthcare FSAs are pre-funded, meaning the participating employee's entire annual contribution is available at the start of the plan year, typically January 1, or after the first contribution to the FSA is received by the FSA vendor. Employees contribute to the FSA in small increments throughout the year through payroll deductions—for example, 1/26 of the annual amount if paid every two weeks—but the full elected amount is accessible immediately.

If an employee experiences a qualifying event during the first period and uses the entire annual contribution, then is terminated, quits, or is unable to return to work, the employee does not have to repay the money to the employer. The IRS views these plans as health insurance plans for tax purposes, so benefits received are not considered taxable income. This pre-funding structure presents a potential risk to employers if employees use their full annual election early and then leave employment, though this risk is typically offset by forfeitures from employees who don't spend all their funds by year-end.

Dependent Care FSAs operate differently and are not pre-funded. Employees can only be reimbursed up to the amount of wages they have contributed to the Dependent Care FSA during that plan year. The FSA payment card may not be used if childcare expenses are pre-paid, since the IRS requires the expense must be incurred before reimbursement can be made.

Eligible employees can enroll in FSAs during their organization's annual open enrollment period, which typically occurs in November and December with coverage effective January 1 of the following year. Current enrollees must remember to enroll each year to continue participating in FSAs because enrollment does not carry forward year to year. New and newly eligible employees who wish to enroll must do so within 60 days after they become eligible but before October 1 of the calendar year.

Once enrolled, the annual contribution amount must remain the same throughout the year unless certain qualifying life events occur. The IRS detailed in 1997 and 1998 the circumstances when an employee could make changes to an annual election. Eligible events include change in marital status, change in number of dependents, change in spouse's or dependent's employment status, strike or lockout, leave of absence under the Family and Medical Leave Act, change in employment status, change in dependent's eligibility status, significant change in costs for or coverage by employer-sponsored health plan, change in residence or work site of employee or spouse or dependent, participant's failure to pay premiums, change based on special enrollment rights under the Health Insurance Portability and Accountability Act, court-ordered change, and entitlement to Medicare or Medicaid.

FSAs provide significant tax savings because contributions are deducted from employees' paychecks before federal income tax, employment tax (FICA), and in most cases state taxes are applied. Employees save an amount equal to the taxes they would have paid on the money set aside, typically averaging 30% based on combined federal, state, and FICA tax rates. For example, a household making the median U.S. household income of $74,580 that elects the full FSA contribution for 2024 ($3,200) would save approximately $1,000 in payroll taxes over the course of the year.

Employers also benefit from tax advantages. Instead of paying payroll taxes to the government on the amounts employees contribute to FSAs, employers typically pay only a small administrative fee to the plan of $4-10 per month per participating employee. This represents substantial savings compared to what the employer would have paid for its share of payroll taxes. Additionally, any money not used by employees by the end of the plan year or grace period is returned to the employer, which can amount to approximately 14% of total employee contributions.

Distributions from FSAs for eligible expenses are not subject to taxation. This triple tax advantage—tax-free contributions, tax-free growth (in the form of tax savings), and tax-free distributions for qualified expenses—makes FSAs a powerful tool for managing healthcare costs. Employees cannot receive reimbursement twice for the same expense, such as getting both FSA reimbursement and a tax deduction on their tax returns, which would constitute double-dipping.

FSAs are owned by the employer, not the employee, which means the accounts are not portable. If an employee leaves their job or is terminated, they typically cannot take the money in their FSA with them. The coverage period ends when coverage under the plan ends, such as at separation from the employer. Employees who do not elect and pay for continued coverage under the plan through COBRA lose access to their FSA funds.

For example, if a person is employed by a company from January through June and covered on their cafeteria benefits plan (including FSA) during that time but does not elect COBRA coverage, the coverage period is defined only as January through June, not the full calendar year. All covered expenses must be incurred during the actual coverage period. However, employees may continue to submit claims during the run-out period for expenses incurred before their coverage ended. Any unused contributions remaining after the run-out period are forfeited, even if the employee contributed more than they were able to spend due to early termination.

Employers offering FSAs must comply with several federal regulations. The Employee Retirement Income Security Act (ERISA) requires employers who offer welfare benefit plans to create written Plan Documents and Summary Plan Descriptions and provide them to employees. These documents communicate plan benefits and how each plan operates, and must be stored electronically with date and time stamps of originals and revisions.

The IRS requires employers to perform Non-Discrimination Testing (NDT) each year to prevent key and highly compensated employees from receiving a disproportionate amount of employer-provided tax-free benefits compared to rank-and-file employees. Failure to satisfy nondiscrimination testing requirements or take necessary corrective measures can result in inclusion of discriminatory benefits in the income of highly compensated employees as taxable income.

California has additional requirements. Effective for plan years beginning on or after January 1, 2020, California employers that sponsor FSAs must notify participants of any deadline to withdraw funds before the end of the plan year. The notice must be sent to all participants who work in California using at least two methods (email, telephone, text message, postal mail, or in-person), with only one method allowed to be electronic. The Patient Protection and Affordable Care Act amended Section 125 to cap FSA annual elections at limits determined by the IRS, currently $3,400 for 2026, to prevent unlimited pre-tax contributions.

A Flexible Spending Account is often compared to 3 related concepts:

Flexible Spending Account vs. Health Savings Account

FSAs and HSAs both offer tax advantages for healthcare expenses, but HSAs are owned by the individual rather than the employer, meaning funds roll over year to year and belong to the participant regardless of employment status. HSAs are only available to individuals enrolled in high-deductible health plans, while FSAs can be paired with any health insurance plan. HSA funds can be invested and grow over time with tax-free returns on investments, whereas FSA funds cannot be invested. HSAs are portable and go with the employee if they change employers or retire, while FSAs are forfeited upon employment termination. However, FSAs make the total annual contribution available on day one of the plan year, while HSA funds are only available as they are contributed. Employees cannot typically have both a general Healthcare FSA and an HSA simultaneously, though Limited Purpose FSAs are designed specifically to be HSA-compatible.

Flexible Spending Account vs. Health Reimbursement Arrangement

Both FSAs and HRAs help employees pay for out-of-pocket healthcare costs with tax advantages, but HRAs are funded solely by employers with no employee contributions required, while FSAs are funded by employee payroll deductions with optional employer contributions. HRAs are owned and controlled by the employer, similar to FSAs, but the reimbursement structure and eligible expenses can be more customized by the employer in an HRA. Both accounts are subject to use-it-or-lose-it provisions, though the specific terms vary by plan. HRAs are often used in conjunction with high-deductible health plans as an alternative to HSAs.

Flexible Spending Account vs. Health Insurance Deductible

A health insurance deductible is the amount an individual must pay out of pocket for covered healthcare services before their insurance plan begins to pay, while an FSA is a tax-advantaged account that can be used to pay deductibles and other eligible expenses with pre-tax dollars. Deductibles are a feature of insurance plan design that determines when coverage starts, whereas FSAs are a separate benefit that provides tax savings on money used to pay deductibles, copayments, coinsurance, and other qualified expenses. FSAs effectively reduce the after-tax cost of meeting deductibles by approximately 30% due to the tax savings on contributions. All health insurance plans except those with first-dollar coverage have deductibles, but FSAs are optional employer-sponsored benefits.