Guide to flexible spending accounts (FSAs)

Flexible benefits are essential for attracting and retaining employees

With the cost of traditional benefits—like group health insurance—rising each year, many employers wonder how they can offer competitive benefits that attract and retain employees, even in a tight labor market.

Offering flexible benefits is an excellent way to address the wants of your employees while bolstering your benefits package. One popular flexible benefit option that empowers employees is a flexible spending account (FSA).

In this guide, we'll show you how FSAs work as a flexible benefit to help your employees better access the medical care and services they desire. We'll also compare them to popular alternatives to help you find the right benefits solution for your organization.

Topics covered in this guide include:

• History of flexible spending accounts
• What is a flexible spending account?
• Who is eligible for a flexible spending account?
• Types of FSAs
• Pros of FSAs
• Cons of FSAs
• FSA rules and requirements
• FSA alternatives
• Comparing FSAs to HRAs
• Offering an FSA alongside an HRA
• FSA FAQs

What is a flexible spending account?

A flexible spending account (FSA), also called a flexible spending arrangement, is a type of spending arrangement that allows employees to use tax-advantaged money for various eligible expenses.

The most popular form of FSA is a healthcare FSA, also called a medical FSA. This medical reimbursement plan allows employees to use pre-tax dollars to cover their qualifying medical costs. This includes out-of-pocket healthcare expenses such as doctor visit copays, vision expenses, medical equipment, over-the-counter medicine, and prescription drugs. FSAs don't cover health insurance premiums. Any employee of an organization or agency that offers an FSA is eligible for an FSA.

Employee contributions to FSAs come from payroll deductions, and employers can also make contributions. Unlike a health savings account (HSA), which allows contributed funds to remain in the account indefinitely, anFSA has a “use it or lose it” provision, meaning that funds not used by the plan year's end will expire. The IRS updates maximum annual contribution limits each year.

Employees may withdraw FSA funds tax-free to pay for qualified expenses. Typically, with a healthcare FSA, employees must submit a claim to their employer through their FSA with proof of their medical expenses. Their employer will reimburse them if their group health insurance plan doesn’t cover the expense.

Who is eligible for a flexible spending account?

Any employee is eligible to contribute to an FSA. Only employers can establish an FSA for their employees. Employers can offer FSAs alongside other employee benefits as part of a cafeteria plan.

You can't use an FSA if you have a marketplace plan. Instead, you can establish an HSA, or the employer can offer a health reimbursement arrangement (HRA).

You can't participate in an FSA if:

• You are a 2% or more stakeholder in an S corporation, LLC, LLP, PC, or partnership.
• You're a business owner, and your business is a sole proprietorship.

Types of FSAs

There are many types of FSAs available for employees. This includes the healthcare FSA, dependent care FSA, adoption assistance FSA, and the limited expense healthcare FSA (also called a limited-purpose FSA).

We'll break down the most common types of FSAs below.

Healthcare FSA

The most common type of FSA is a health FSA, also known as a medical FSA. A healthcare FSA allows employees to use pre-tax dollars for out-of-pocket medical expenses such as doctor visit copays, prescriptions, deductibles, and other eligible medical expenses. These eligible expenses are available in IRS Publication 502.

A healthcare FSA's maximum annual contribution limit is $3,300 in 2025, up from $3,200 in 2024. Additionally, if employers allow the funds to carry over, the maximum carryover amount will increase to $660 for 2025.

Limited-purpose FSA

A limited-purpose FSA allows employees to pay for qualified vision care and dental expenses. It doesn't cover medical expenses, as employers offer it to pair with a health savings account (HSA). Annual contribution limits are the same as healthcare FSAs.

Dependent care FSA

A dependent care FSA, or child care HSA, allows employees to pay for employment-related dependent care services on a pre-tax basis. A dependent is someone who can't take care of themselves, including children under age 13 and adult dependents with physical or mental disabilities.

The maximum annual contribution limit didn't change for 2024. It's $2,500 for married couples filing separately and $5,000 for single people and married couples filing jointly. The minimum annual election for each FSA also remains unchanged at $100.

Eligible dependent care expenses can include:

• Eldercare
• After-school programs
• Babysitting due to work
• Hiring a nanny
• Preschool
• Nursery school
• Daycare expenses

A dependent care FSA doesn't cover tuition and is only available for dependents younger than 13.

Adoption FSA

With an adoption FSA, employees can set aside pre-tax money for expenses incurred while adopting a child.

The maximum contribution limit for adoption assistance FSAs is $17,280 for 2025, up from $16,810 in 2024.

Commuter FSA

A commuter FSA allows employees to pay for employment-related commuter services on a pre-tax basis. There are two separate commuter FSAs available: the transit FSA and the parking FSA.

The annual contribution limit for commuter FSAs increased to $325 for 2025.

FSA rules and requirements

These tax-advantaged accounts can be an extremely valuable benefit to your employees. However, there are rules and regulations you must follow to stay compliant.

If an employer offers an FSA alongside a cafeteria plan, it’s subject to IRS Code Section 125. However, if you don’t offer an FSA through a cafeteria plan, it’s subject to Section 105 instead.

Employer contributions

If an employer decides to contribute to an employee's healthcare FSA, the IRS allows an employer match separate from employee contribution limits. An employer can contribute up to $500 to a healthcare FSA, no matter if the employee contributes. Starting at $501, employers can only match dollar-for-dollar contributions.

Employers can also limit how much they want to contribute to an FSA. For example, suppose an employee contributes $1,000 to a healthcare FSA. In that case, an employer can decide to either match that and contribute $1,000 or cap contributions at any dollar amount they choose, such as $500.

You must include employer contributions to long-term care insurance through an FSA in an employee's income.

Employee contributions

Employees contribute to their FSA by electing to have money voluntarily withheld from their pay through a salary reduction agreement. Employees don't pay federal income tax or employment taxes on their contributions.

Your employees can choose their contribution amounts at the beginning of the plan year. Then, you can deduct the amounts periodically by the annual election. Employees can change or revoke elections only if there's a change in employment or family status specified by the plan or during your benefit's open enrollment.

Distributions

Employers reimburse employees for qualifying expenses incurred during the plan year. Employees are eligible for the maximum reimbursement under your plan at any time during the plan year, regardless of how much you or your employee contributed. These distributions aren't counted as taxable income for payroll taxes or federal taxes.

You can't reimburse employees for health insurance premiums, long-term care coverage, or any medical expenses covered under another plan, such as health insurance or an HRA.

Any reimbursements made for non-qualifying expenses count as taxable income.

A third-party administrator must substantiate all FSA expenses. An FSA debit card is also a popular feature for automatically substantiating purchases.

Grace period and carryover funds

Employers can allow unused healthcare FSA funds to carry over into the following year. The IRS caps the carryover for unused funds at $640 for 2024. If employers choose not to have a carryover balance, they can set up a two-and-a-half-month grace period for employees to use their remaining FSA funds.

However, employees can't choose to have both a grace period and a carryover balance. They must choose one or the other, or neither.

Tax reporting

Unlike HSAs, employees don't need to report FSAs to the IRS on their income tax returns. You also don't need to report FSAs on Form 1040.

Non-discrimination testing

FSAs, like other employee benefits, are subject to non-discrimination testing. This allows you to show that your benefits plan complies with federal non-discrimination laws for highly compensated employees, officers, and owners.

ERISA requirements

Since an FSA falls under ERISA, employers must file Form 5500 with the IRS to report their plan information each year. You'll also need to offer COBRA for qualified employees.

All FSAs must have plan documents and provide employees with a summary plan description (SPD).

Alternatives to flexible spending accounts

If you're looking for affordable and personalized employee benefits, you can also offer your employees a health reimbursement arrangement (HRA) or employee stipend.

HRAs

An HRA allows employers to reimburse employees, tax-free, for their qualifying medical expenses. Unlike an FSA, an HRA allows you to reimburse employees for individual health insurance premiums in addition to vision care, dental services, and out-of-pocket medical expenses.

You can provide an HRA as an alternative to traditional group health insurance plans, saving you money while giving your employees more freedom to choose a health plan that works best for them. A qualified small employer HRA (QSEHRA) and individual coverage HRA (ICHRA) are excellent options for providing your employees with health benefits.

If you are looking for an alternative to an FSA to supplement your group health plan, a group coverage HRA (GCHRA), also known as an integrated HRA, supplements your group health policy and can be paired with any type of plan, such as a high deductible health plan (HDHP).

Determining which HRA is best for your organization depends on the level of flexibility and control you want over your benefit.

Employee stipends

Instead of offering an FSA for dependent care, adoption, or commuter benefits, you can provide your workers with an employee stipend. An employee stipend is a sum of money employees can use for the expense categories you choose. For example, you can offer a monthly allowance for commuter benefits such as mass transit passes or a wellness stipend for gym memberships and mental health resources.

Employee stipends are completely customizable to your organization's needs for any expense you can think of. While some fringe benefits, such as commuter benefits, are tax-free up to the IRS annual limit, others are taxable.

Offering an FSA alongside an HRA

If you're interested in both FSAs and HRAs for your organization, you can offer both benefits at the same time! This can be an excellent way to optimize your tax savings and flexibility. However, there are rules you'll need to follow to ensure your benefits are compliant.

When offering an FSA and HRA:

• You can't reimburse the same expenses for both accounts.
• Unless otherwise specified in your plan documents, your employees must use their available HRA allowance first before they can use their FSA.
• You can't offer an FSA alongside a QSEHRA. You can't combine a QSEHRA with any traditional health plan. The IRS considers an FSA a group health plan.

Frequently asked questions about flexible spending accounts

What is the difference between an HRA, HSA, and FSA?

An HRA is an arrangement between an employer and an employee. It allows employers to reimburse employees for their qualifying medical expenses. An FSA is an account funded by both employers and employees for medical expenses, dependent care, adoption assistance, or commuter benefits. An HSA is a portable account owned by the employee.

Learn more about the differences between HRAs, HSAs, and FSAs with our comparison chart

How do I qualify for an FSA?

To qualify for an FSA, your employer must offer the benefit, and you must elect to participate. All employees are eligible to participate.

How can I use my FSA money?

Depending on your FSA type, you can spend your tax-free money in various ways. With a health FSA, you can use your money on out-of-pocket medical expenses, such as your deductible, co-payments for medical care and prescription medications, or bills not covered by insurance, such as vision and dental care.

A limited-purpose FSA only allows you to use the money on medical expenses your insurance doesn't cover. This might include vision expenses such as contact lenses and eye exams, or dental expenses.

How do you administer an FSA?

Most organizations hire a third-party administrator to set up and help administer the FSA.

Does FSA come out of my paycheck?

Yes, FSA funds come from employees' paychecks on a pre-tax basis. This means that you aren't taxed on the amounts deposited into your FSA. Employers can also contribute to an employee's FSA

Is an FSA “use it or lose it”?

Yes, FSAs are “use it or lose it” benefits, meaning any leftover funds at the end of the plan year stay with the employer, not the employee. Organizations can choose to allow up to $640 to roll over to the next year or create a two-and-a-half-month grace period.

What does an FSA not cover?

An FSA doesn't cover health insurance premiums. A health FSA only covers out-of-pocket medical expenses listed in IRS Publication 502.