What Is an FSA and How Does It Work?

A flexible spending account (FSA) allows employees to manage their medical and other expenses while also saving money on taxes. As an HR professional, understanding this benefit will allow you to better advise your employees on which health benefits are best for them.

1.0 What is a flexible spending account (FSA)?

An FSA allows an employee to allocate a certain amount of their income to be used for specific qualified expenses. FSAs are also referred to as flexible spending arrangements. To participate in an FSA, you must work for a company that offers them. Additionally, employees do not need to have a health insurance plan to open an FSA with their employer.

Feature	Details
Tax Treatment	Contributions on a pre tax basis, reducing federal taxes and payroll taxes
Eligible Expenses	Co pays, deductibles, prescription medications, over the counter medications
2025 Limit	Maximum healthcare FSA contribution is $3,300 per employer for 2025
2026 Limit	FSA contribution limit is $3,400 for 2026
Savings	Approximately 30% savings on eligible expenses

1.1 How does an FSA work through a section 125 cafeteria plan?

FSAs are established within a Section 125 Cafeteria Plan, which allows each employee to choose which benefits to take that are not taxable. By contributing to an FSA, those contributions will be withdrawn from the employee's paycheck before taxes are applied to their paycheck.

1.2 How do pre tax payroll deductions fund an FSA?

Employees contribute to an FSA by placing a portion of their salary before taxes are deducted from their paycheck. Such funds are made available to the employee at the start of the plan year. This initial contribution to the FSA is different from an HSA, wherein only the deposited funds are accessible to the individual.

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2.0 What is the difference between an HSA and FSA?

Understanding what is an FSA becomes clearer when compared to an HSA. Both an FSA and an HSA offer tax advantages to the individual if their funds are used for qualified health care expenses. There are, however, differences between each account that are important for HR professionals to understand and discuss with their employees.

Criteria	FSA	HSA
Ownership	Employer owned	Employee owned savings account
Rollover	Unused FSA funds may be forfeited at year end	HSAs allow carrying over unused funds indefinitely
Investment	Cannot invest fsa money	Can invest HSA funds for potential growth over time
Limits	Lower contribution limits	Higher hsa contributions allowed
Combined Use	Can pair limited purpose FSA with HSA	Cannot pair with full healthcare FSA

3.0 Types of flexible spending accounts

Now that you know what is an FSA, it is important to understand the different types available. There are several different types of flexible spending accounts available to employers and employees. These include healthcare FSAs, dependent care FSAs, limited purpose FSAs, post-deductible FSAs, and qualified transportation FSAs.

Healthcare FSA

A healthcare FSA is the most common type of FSA and allows employees to use their pre-tax contributions towards medical, dental, and vision expenses. Examples of qualifying expenses include contact lenses, blood pressure monitors, eyeglasses, and eyeglass cleaning solutions, sunglasses, and lenses; dental expenses such as dentures, dental X-rays, and cleaning services; and vision expenses such as eye exams and eye drops.

Dependent care FSA

A dependent care FSA allows employees to use their FSAs to pay for daycare for children under the age of 13 or for elderly dependents that require care. The limit on these contributions for 2026 will be $7,500 per household. For married couples that file taxes separately, the limit will be half of the contribution limit for a single taxpayer.

Limited purpose FSA

A limited purpose FSA is similar to a healthcare FSA but with limited use. These contributions can only be used for dental and vision expenses. Limited purpose FSAs can be established in conjunction with an HSA.

Post deductible FSA

A post-deductible FSA is similar to a limited purpose FSA but allows the employee to use their FSA to pay for dental and vision expenses until they meet their health plan deductible. After meeting their health plan deductible, the FSA can be used for medical expenses instead.

Qualified transportation FSA

A qualified transportation FSA allows an employee to use their pre-tax dollars to cover expenses related to commuting to work.

4.0 How a flexible spending account (FSA) works

Knowing what is an FSA is only the first step — understanding how it works in practice is essential. According to a 2024 survey of HR professionals, 63% of employers have an FSA as part of their employee benefits package. As an HR professional, you must understand how these plans work.

Step 1: Employees select how much money they would like to contribute to their FSA for the upcoming year.

Step 2: Each paycheck, that amount will be deducted from the employee's paycheck before their federal taxes are calculated.

Step 3: The employee will experience an eligible expense.

Step 4: Using an FSA debit card or submitting a receipt, the employee will pay for those eligible expenses.

Step 5: The FSA administrator will reimburse the employee with their health care FSA funds.

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4.1 What is the use it or lose it rule?

Generally, FSAs use the "use it or lose it" rule, which means any remaining balance in an employee's FSA at the end of the plan year will be lost. Some employers may offer a grace period or a carryover option for FSAs but will not offer both. Carefully calculate the amount of health care expenses that an employee will have during the coming year to avoid losing any FSA funds.

4.2 What is the FSA grace period and how does it work?

An FSA grace period allows an employee an additional 2.5 months after the FSA plan year end date to use their FSA funds for eligible purchases. For example, if an employee's FSA plan ends on December 31 of the current calendar year, they will have an additional 2.5 months to make purchases with their FSA card or receive reimbursement for eligible expenses. Such a period will extend until March 15 of the following calendar year.

4.3 What is the FSA carryover provision and how is it different from a grace period?

An FSA carryover provision allows an employee to transfer their remaining FSA funds into the following plan year. For 2026, the limit is $680. Unlike the grace period, there is no time limit for a carryover provision. Some employers may offer this provision but will not offer both a carryover and a grace period for FSAs. Consult with a tax advisor to determine the details of each provision or refer to the IRS limits for each provision.

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5.0 FAQs

Here are the common questions about flexible spending account:

5.1 Can you have an FSA and an HSA at the same time?

An employee can have a limited purpose FSA and an HSA at the same time. With a limited purpose FSA, the employee can have funds dedicated to purchasing dental and vision products or services. With an HSA, the funds may be used for medical expenses. An employee cannot have a healthcare FSA and an HSA at the same time.

5.2 What happens to your flexible spending account if you leave your employer?

If an employee leaves their employer, they will generally lose any remaining funds in their FSA. Unless the employee chooses to take advantage of the employer's COBRA healthcare plan, they will lose any remaining funds in their FSA account.

5.3 Can employers contribute money to an flexible spending account?

An employer can contribute to their employee's FSA account. However, they are not required to.

5.4 How do you claim reimbursement from an flexible spending account?

An employee can receive reimbursement from their FSA by using an FSA card at the point of purchase of an eligible product or service. If an employee purchases an item with their FSA but does not want to use their FSA card, they can submit a receipt to their administrator to be reimbursed for that purchase.

5.5 What does a dependent care FSA cover?

With a dependent care FSA, employees may use their account to pay for child care or elder care for their dependents while they are working. For 2026, the limit for each employee will be $7,500 per household. For married couples that file separate taxes, the limit will be half of the amount for single filers. This account does not cover health care expenses or health insurance premiums.