What Is an FSA?
In the United States, health care ranks as one of the most sought-after employee benefits, as employees want the reassurance of medical coverage for themselves and their family. To extend the usefulness of these benefits, a flexible spending account (FSA) can be offered to further assist with managing medical costs.
An FSA allows employees to use pretax dollars to pay for eligible out-of-pocket health care expenses such as co-pays, prescription and over-the-counter medications, vision care, and dental work, for themselves, their spouse, and eligible dependents. These account-based plans are voluntary, and employers can make contributions on top of employees' pretax contributions.
It's important to note that FSAs are not the same as health savings accounts (HSAs) although the two have similarities. Both allow enrollees to save money to pay for qualified medical expenses with pretax dollars, but there are key differences between these arrangements.
How Does an FSA Work?
An FSA is a voluntary plan that allows enrolled workers to contribute up to an annual maximum of $2,850 in 2022 to pay for eligible medical expenses not covered by their health insurance. If your business offers group health insurance, you can offer your workers this additional benefit.
Additionally, employers may choose to subsidize or match workers' FSA account contributions. Employer contributions generally do not count toward the FSA limits for contributions, unless employees elect to receive the employer contributions in cash or as a taxable benefit.
Benefits of an FSA
An FSA plan offers benefits to both employees and employers. Some of the most important advantages include tax savings and more effective management of employees' out-of-pocket medical costs.
- Employer tax savings: Employers pay less in their portion of FICA and FUTA payroll taxes, as employee contributions to an FSA are not subject to these taxes.
- Medical savings: Enrolled workers use pretax dollars (an annual maximum of $2,850 for 2022) to pay medical expenses not covered by their health insurance.
- Effect on take home pay: Employees can contribute a set amount of pretax dollars toward their FSA balance to cover medical expenses. This may give employees more take-home pay because they pay less in taxes.
- Immediate access to account: Funds can be monitored online and employees can gain immediate access to their account through an FSA debit card.
- Evenly spaced savings to manage costs: FSAs allow employees to save evenly throughout the year, which helps to budget and manage large health care costs. Carryover rules also help to limit last-minute spending to avoid the "use it or lose it" mentality.
- No required payback of reimbursed funds: FSAs require that contributions come from each paycheck throughout the year, but the full annual contribution amount is available for use immediately (or after the first contribution). If the employee uses the full amount and then quits or is fired before year-end, they do not have to repay FSA funds to the employer.
It is up to employees to decide how much they want to contribute to an FSA using payroll deductions. Typically, participants use their contributions to an FSA to reimburse themselves for co-payments and other out-of-pocket, non-covered medical expenses. Most dental expenses also qualify, such as costs for non-cosmetic orthodontics and extractions. Other FSA-eligible expenses include:
- Eyeglasses/contact lenses;
- Laser eye surgery;
- Medical monitoring devices;
- Walking assistance devices;
- Wheelchairs and repairs; and
FSA participants pay for approved items or services with an FSA debit card, or use an account reimbursement service when they submit substantiation for eligible expenses. However, FSAs don't cover everything. Participants cannot use their account funds for:
- Cosmetic surgeries provided for reasons other than correcting congenital deformities, disease disfigurement, or to correct personal injuries that result from accidents or trauma;
- Childbirth class expenses for the coach (those for the expectant mother are covered);
- Exercise equipment for general well-being;
- Marriage counseling;
- Special foods that represent normal consumption and satisfy nutritional requirements;
- Treatments from alternative providers;
- Personal care items;
- Infant formula;
- Funeral expenses;
- Payment of insurance premiums; or
- Prescription drugs from another country.
FSAs will cover over-the-counter drugs and remedies. Examples of these FSA-eligible items include:
- Indigestion medications;
- Eye drops;
- Pain relievers;
- Sleep aids;
- Acne medications;
- Diaper rash ointment; and
- Ointments for minor injuries.
In collaboration with Paychex, the FSA Store provides an expansive list of FSA-eligible items on which employees to use funds.
Employer Advantages of Offering an FSA
The value of FSAs extends to employers who often see increased retention rates and employee satisfaction as a result of offering this flexible benefit. There are also notable tax advantages. Because enrolled employees reduce their taxable income with FSA contributions, employers pay less in Medicare and Social Security taxes (FICA taxes). The more employees who enroll, the more savings for the company.
FSAs also enhance one of the benefits employees value most: health care coverage. Health savings accounts allow employers to help their workers and their dependents pay for medical expenses not covered by the group insurance plan — a benefit that contributes significantly to employee retention, morale, and loyalty.
Considerations for Employers and Employees
If you wish to offer employees an FSA plan, the timing of your decision is imperative. Ideally, your new FSA should be ready to go prior to open enrollment for the following year. This will allow employees to do their research and make their plan elections accordingly. If you currently offer an FSA and need to amend your plan, be sure to communicate any changes to participants.
Before enrolling in an FSA, employees should attempt to project their reimbursable health care expenses for the year and decide if it makes sense to set aside money each pay period to cover them. You don't want to lose contributed funds when you don't have the necessary medical expenses. Looking back at past years' expenses can help determine if it makes sense to enroll in and FSA.
What Is the FSA Carryover or Grace Period Option?
Although not required, employers have two options they can institute to help employees take advantage of all the money they've contributed into their FSAs.
- Allow employees to carry over up to $570 of unused health FSA money at the end of the year to apply to the next plan year (remaining funds in excess of $570 are still forfeited to the plan); or
- Elect a grace period to permit employees to use their unused account balances to pay for medical costs incurred during the first 2.5 months of the next plan year (up to March 15 for calendar year plans) before they must forfeit the money.
Before making a final decision, employers should carefully weigh the benefits of any insurance benefit account like an FSA and also understand the administrative requirements of a carryover or grace period option.
When Do You Need To Pick the Carryover or Grace Period Option?
Both options are intended to reduce "wasteful" end-of-year spending as employees hurry to spend their FSA accounts rather than lose the money. Employers are not required to offer either option, in which case the traditional "use it or lose it" rule will still apply. But if you do choose to offer one of these options to your workforce, you must pick only one, as employers cannot allow employees both a carryover and a grace period for their health FSA. You may wish to review any available data on current FSA utilization before deciding which option would work best for your company's workforce. Once you make your selection, notify employees as soon as possible to give them enough time to make an account selection and adjust their medical spending as needed.
Communicating to Employees About FSAs
If you want employees to take full advantage of an FSA benefit, you must strive to clearly communicate how they can best utilize the plan. A well-drawn benefits communication strategy can enhance your employees' understanding of how to enroll in the FSA and receive the maximum benefits. While information on FSAs should be included in open enrollment, it must also be provided to new hires when they become eligible for benefits. FAQs and other health plan information may also be provided online via a company benefits portal. Keeping in mind that employees' communication preferences may vary, you may want to make print copies of this information as well. A strong communication plan should consider the following:
Communications efforts should be designed to educate employees on the benefits of an FSA. Explain why they might want to use this type of plan. Commonly asked questions and examples that break down different cost scenarios can be provided, along with key enrollment dates. You'll also want to remind employees about any FSA spending deadlines and clearly explain the carryover or grace period options made available to them.
Aim to make your communications easy to understand and present them in a conversational tone, where possible. An FSA grace period is often referred to as the "2.5 month grace period." This may make perfect sense to HR professionals, but your staff may be confused by such types of industry jargon. When you communicate the details of the FSA grace period to employees, for example, describe it using specific dates and deadlines. Also, communicate what will happen if they fail to take action, such as a forfeiture of contributions.
Provide Helpful Tools
Janelle Rodriguez, Paychex HR consultant, suggests resources like the Paychex FSA enrollment material, which offers a list of expenses-at-a-glance for enrollees to review. "Paychex partners with the FSA Store, which also provides an expansive list of items that are FSA-eligible, while also offering a means for employees to use their funds." She says a quick reference tool (like a one-pager or web page) listing common items employees can use their FSA funds to pay for is also helpful. These useful types of communications tools can take the burden away from busy HR professionals.
Setting Up an FSA
If you're not currently offering an FSA, this can bring tax savings for both you and employees as well as provide a much desired add-on to your health benefits. Paychex offers assistance with FSA implementation, ongoing administration, and the development of employee communications to encourage participation.