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Definition of a Flexible Spending Account

A flexible spending account (FSA) is a tax-sheltered plan that is offered through employers as part of their cafeteria plan benefits. Employers are not required to offer their employees FSAs; however, they can provide a substantial incentive for employees with certain types of expenses, such as medical or dependent care.

  1. Medical FSA

    • The two primary types of FSAs are for medical expenses and dependent care. The medical FSA allows tax-free payment of health care costs not already covered by the company's health care plan. These costs include co-payments, deductibles and non-covered medical expenses. Other costs normally allowed as a medical expense deduction on an income tax return are also eligible, such as bandages, oxygen and wigs for chemotherapy patients.

    Dependent Care FSA

    • A dependent care FSA allows employees to use the plan to pay for child care or elder care costs for dependents living at home. This type of plan is only available for families where both parents work outside of the home or are disabled or in school full time. As of 2011, the maximum allowable reimbursement from the plan is $5,000 per year per household. Eligible child care costs are for children under 13 or for older children who are disabled. Plan funds can also be used to take care of a dependent parent or grandparent as long as he meets the IRS criteria to be considered a dependent for tax purposes.

    Withdrawing Money From an FSA

    • Each FSA is different with respect to how funds in the plan can be accessed. Some require that the employee pay the expense first and then submit a claim to the plan administrator for reimbursement. This forces the administrator to assess the validity of the expense. Some plans offer FSA debit cards that give employees direct access to their accounts, and the debit cards can be used to pay for medical expenses directly. The verification process is still in place in these situations, and documentation is still required.

    Pros and Cons of an FSA

    • One of the main benefits of FSAs to employees (and a disadvantage to employers) is that, with most plans, the entire amount of the employee's annual contribution is available at the beginning of the year. For example, if an employee's annual contribution to the FSA is $2,500 split evenly among her paychecks throughout the year, that $2,500 is available for withdrawal on January 1. If the employee uses more than she has contributed in a year and then quits, the employee is not required to repay the amount. Beginning January 2011, there are restrictions on what can be purchased with a medical FSA. Over-the-counter drugs are not qualified expenses unless the employee has a prescription.

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