Q: Tax Playa, what is a flexible spending account (FSA), and how does it differ from an HSA or HRA?
Sharon, Arlington VA
A: An FSA is a tax-advantaged spending account for health care. Money goes in every week out of your paycheck, and is used to pay for your out-of-pocket health care costs (copays, deductibles, eyeglasses, etc.). The big limitation on these accounts is that whatever you put in must be spent by the end of the year (or, in some cases, a grace period until the next March), or you lose the money...
For more on FSAs, see IRS Publication 969, HSAs and Other Tax-Favored Health Plans.
First, let's clear up what FSAs are not.
- FSAs are not HSAs. HSAs (or "health savings accounts") are tax-advantaged savings accounts connected to a high-deductible health plan. Whatever is not spent rolls over and grows like an IRA.
- FSAs are not MSAs. MSAs (or "medical savings accounts") are the ancestor of the HSA, and work in much the same way.
- FSAs are not HRAs. HRAs (or "health reimbursement arrangements") grow and build over the years, but are tax-advantaged accounts of the employer, and revert to the employer after you leave that job.
An FSA is established as a payroll deduction by your employer. They are sometimes known as "Section 125 plans" or "cafeteria plans." You decide how much money you want to deduct from each paycheck to go into the accounts. The deduction is both pre-income tax and pre-FICA, so many people can save about $0.40 on the $1.00.
You can only change how much you want to go into the account over the course of the year if there is a change in your family or employment status. There is no limit on the amount that you can contribute, but you must use up all of the money by the end of the year, or you lose it (meaning it reverts to the employer). In some cases, your FSA plan will allow for a grace period of up to ten weeks after the end of the plan year (in the case of a calendar year this would be about March 15th).
You can use the money in your FSA for most out-of-pocket medical expenses (that is, those not already paid for by insurance, your employer, or another tax-advantaged method). These normally include:
- co-payments for prescription medicines and office visits
- deductibles on your health care plan
For a complete list of allowed medical expenses, see IRS Publication 502, Medical and Dental Expenses.
You are allowed to coordinate an FSA with an HSA or HRA, but there are limitations:
- HSA. You are allowed to roll over unused balances from an FSA into an HSA if you do so by the end of the grace period or the plan year (depending on your plan). If you have an FSA during the grace period, this does not disqualify you for HSA contributions. You can maintain an FSA and an HSA at the same time if you only use the FSA for "other coverage" (accidents, disability, dental care, vision care, long-term care, or HDHP payments made after the deductible).
- HRA. You are allowed to use an FSA in conjunction with an HRA. No double benefit is allowed (obviously) and the HRA plan has wide latitude to determine which account pays for which benefits. An FSA can be used to pay for "other coverage" listed in (1). An employer must be careful that an HRA not be the equivalent of an FSA. As a side note, a discontinued HRA can be used in conjunction with an HSA to pay for "other coverage" or retirement benefits.