Flexible Spending Account: What is it, Pros, Cons & Are They Worth it?

A flexible spending account is another tax-advantaged savings account. It’s one of the better options most employees have to save for out-of-pocket healthcare expenses.

Of course, before you decide to enroll with your employer, you may be wondering:

First of all, what is an FSA?
What benefits does an FSA offer?
What are the pros and cons of enrolling in an FSA?
In the final assessment, is an FSA worth it?
What are the qualifications for FSA enrollment?

In this article, we will break these questions down and touch on some other options you can defer to if you’re worried about saving for medical expenses.

What is an FSA?

A flexible spending account (FSA) is a type of savings account with some significant tax advantages. However, they also carry some special rules.

The flexible spending account is named in reference to the arrangement between employer and employee. If your employer offers an FSA, you can contribute a portion of your normal earnings to it.

Then, your employer may also contribute to your account. Distributions from the FSA are used to reimburse you in the event you need qualified medical or dental services.

Essentially, an FSA is a piggy bank that you contribute to and then pull from when/if you have certain out-of-pocket healthcare expenses.

The advantages of a flexible spending account are:

They are filled with pre-tax earnings, reducing your taxable income while saving for emergencies
If you’re married, your spouse can also contribute up to the annual contribution limit through their employer
In the case of those spousal contributions, your limits are not affected
You are not taxed for employer contributions either

Dependent Care FSA

A dependent-care flexible spending account is another type of FSA.

It is used to pay for childcare expenses for your children until age 13. Of course, it can also be used for the care of adult dependents. Adult dependents must meet the IRS guidelines, and essentially are adults who are incapable of caring for themselves.

What qualifies for flexible spending account?

There are only two types of FSA, as we’ve covered. Both are offered through employers, and enrolment can be completed during the enrolment period (more information under “Can anyone open an FSA?”.)

What are the pros and cons of an FSA?

Pros

You have something of a tax-advantaged alternative to a simple emergency savings account.

FSA funds are used to reimburse payments for medical care. Qualifying payments are well-defined, and include:

Diagnosis
Treatment
Cures
Mitigation
Prevention

Notably, this also includes reimbursements for non-prescription insulin.

In addition, all of the above can be covered for your spouse and dependents.

These include items such as bandages, crutches, and diagnostic medical devices. Importantly, prescription drug costs, which aren’t covered by all Medicare plans, are covered by your FSA. The CARES Act permanently expanded coverage to:

Drug costs, including non-prescription drugs
Menstrual care products

Deductibles and copayments are also coverable by your FSA.

Cons

Like similarly tax-advantaged accounts, your flexible spending account has limits.

The 2022 contribution limit is $2,850, a $100 increase from 2021. However, the dependent care FSA limit did not change from 2021.

While most important medical expenses are covered, you cannot use FSA funds for all medical expenses. Cosmetic expenses including surgeries are not included. Other expenses that may lead to better health, such as gym memberships, are also not included.

While deductibles and copayments are also coverable by your FSA, your insurance premiums are not.

Can anyone open an FSA?

Not quite, but most people can.

Most full-time employees meet the eligibility requirements for participation in an FSA. If your employer offers health insurance, you almost certainly qualify. You don’t even need to enroll in a health insurance plan to qualify for an FSA.

If you already have an HSA, you should not enroll for a Healthcare FSA. You can still enroll for a dependent care FSA.

The general rule for employee eligibility is:

You must work 30 hours per week or more for your employer
New employees have 30 days upon being hired to enroll in the FSA
You gain eligibility on the first day of the next month following your hiring date
You should enroll for the FSA during the initial enrollment period (FSA Open Enrollment)
Some qualifying significant life events may change your eligibility

Which employees are ineligible for a flexible spending account?

Some types of employees are simply not eligible for an FSA. They include:

Self-employed employees or shareholders who own more than 2% in any of the following entities:

LLC
LLP
S-Corp
PC
Sole proprietorship
Partnership

Employees with HSAs trying to enroll in a regular dependent care FSA

If you have an HSA, you can still enroll in a Child & Elderly Care FSA.

What about business owners?

Business owners are generally ineligible for the tax benefits of an FSA.

The above 2% threshold is explicitly stated by the IRS. Unless you own less than 2% of “your” business, you certainly do not qualify to enroll in an FSA.

Conclusions: Are flexible spending accounts worth it?

For many employees, especially those with health conditions or dependents, yes.

An FSA is a good, tax-advantaged backup fund that is very useful when you’re suddenly faced with out-of-pocket medical and dental expenses.

If you are an employee eligible to enroll in an FSA, it’s normally best to do so. However, there may be special considerations that make it the wrong choice for you.

One great aspect of FSAs is the “F”, flexibility! When you have an FSA, you aren’t under any obligation to contribute a specific amount. The only limitation is the annual contribution limit. So, you can always find a middle ground that makes having an FSA worth it:

You can: