Flexible Spending Account

How an FSA works

FSAs run through a Section 125 cafeteria plan. During open enrollment, the employee elects an amount for the coming plan year. Payroll divides it evenly across the year's paychecks and takes it out before federal income tax and FICA. When the employee has an eligible expense, they pay with an FSA debit card or submit a claim for reimbursement.

Two features make FSAs different from a savings account:

• The election is locked. It can only change mid-year with a qualifying life event, such as a birth, marriage or a change in employment status.
• Use it or lose it. Money left at the end of the plan year is forfeited to the employer, unless the plan offers a carryover or a grace period. Employers can use forfeitures to offset plan costs or reduce future employee contributions, but cannot give them back to the specific employee who forfeited.

Types of FSAs

Health care FSA. Covers out-of-pocket medical, dental, vision and prescription costs: deductibles, copays, glasses, many over-the-counter medicines and menstrual products. It cannot pay insurance premiums. For 2026 the IRS limit on employee contributions is $3,400.

Limited-purpose FSA. Covers only dental and vision costs (and, after the deductible is met, sometimes medical). It exists so employees with a health savings account can still use an FSA without losing HSA eligibility.

Dependent care FSA. Covers care for children under 13 or for a spouse or dependent who cannot care for themselves, so the employee (and spouse, if married) can work. Daycare, preschool, before- and after-school programs and summer day camps usually qualify; overnight camp does not. Starting in 2026 the household limit rose to $7,500 a year ($3,750 if married filing separately), up from the $5,000 limit that had stood for decades. Unlike a health FSA, dependent care money is only available as it is contributed.

Carryover and grace periods

To soften use-it-or-lose-it, a health FSA plan may offer one of two options, not both:

• Carryover: up to an IRS-indexed amount rolls into the next year. For plan years starting in 2026, the maximum carryover is $680.
• Grace period: employees get up to two and a half extra months after the plan year ends to incur expenses against last year's balance.

Separately, most plans have a run-out period, often 90 days, to submit claims for expenses incurred during the plan year. Employees mix up the grace period and the run-out period constantly. Spell out both in plain language with actual dates.

A worked example

Marcus, a claims adjuster earning $52,000 and paid biweekly, expects $1,800 in costs next year: a $1,000 deductible, braces copays and new glasses. He elects $1,800 in his health FSA, which comes to $69.23 a paycheck.

If his combined federal income tax and FICA rate is about 19.65% (12% bracket plus 7.65%), he saves roughly $354 in taxes, more in a state with income tax. In February he has a $1,200 orthodontist bill. Under the uniform coverage rule he can be reimbursed the full $1,200 even though he has only contributed about $277 so far.

The example also shows the employer's risk. If Marcus quits in March after being reimbursed $1,200, he does not owe back the difference, and the employer absorbs the loss. In practice, forfeitures from other employees usually offset it.

FSA vs HSA

The short version: an HSA is a long-term savings account the employee owns; an FSA is a one-year spending account tied to the employer's plan.

• An FSA works with any medical plan. An HSA requires a high-deductible health plan.
• FSA money is mostly forfeited at year end. HSA money rolls over forever and can be invested.
• FSA elections are locked. HSA contributions can change any time.
• A health FSA gives the full annual election on day one. An HSA only lets you spend what is in it.
• An FSA generally ends when you leave the employer, though COBRA may apply to a health FSA in some cases. An HSA is portable.

A related account, the health reimbursement arrangement, is funded only by the employer and has its own rules.

Tips for HR teams

• Help people estimate. Give a simple worksheet: last year's copays, planned procedures, glasses, prescriptions. Over-electing and forfeiting money is the main reason employees sour on FSAs.
• Remind before deadlines. A reminder 60 and 30 days before the plan year or grace period ends recovers money people would lose.
• Tell spouses about HSA conflicts. A general-purpose FSA disqualifies the employee's spouse from contributing to an HSA.
• Promote dependent care FSAs to hourly parents. With the higher 2026 limit, the tax savings on childcare can be worth more than a raise, and many eligible employees never use it. Note that some lower-income employees may do better with the child and dependent care tax credit; suggest they check with a tax advisor.