Flexible spending accounts: Overview, definition, and example
What are flexible spending accounts?
A Flexible Spending Account (FSA) is a tax-advantaged account that allows employees to set aside pre-tax earnings to pay for eligible out-of-pocket medical, dental, vision, or dependent care expenses. FSAs are typically offered as part of an employer-sponsored benefits program and help employees reduce taxable income while covering essential healthcare or childcare costs.
For example, an employee can contribute $2,500 to an FSA and use those funds to pay for doctor visits, prescription medications, and eyeglasses—all without paying taxes on that money.
Why are flexible spending accounts important?
FSAs provide financial benefits by reducing taxable income and making healthcare and dependent care expenses more affordable. Since contributions are made on a pre-tax basis, employees save money while covering necessary costs.
For businesses, offering FSAs can be a cost-effective way to enhance employee benefits and improve workplace satisfaction. Employers may also benefit from reduced payroll taxes since FSA contributions are not subject to Social Security and Medicare taxes.
Understanding flexible spending accounts through an example
Imagine an employee contributes $3,000 to their FSA at the beginning of the year. They later undergo a minor surgery costing $1,500 and use their FSA funds to cover the expense. Because the contribution was made with pre-tax dollars, the employee saves money compared to paying the bill with taxable income.
In another example, a working parent sets aside $4,000 in a Dependent Care FSA to pay for daycare expenses for their child. Since the funds are deducted pre-tax, the parent lowers their taxable income and effectively reduces the cost of childcare.
An example of a flexible spending accounts clause
Here’s how an FSA clause might appear in an employee benefits policy:
“The Company offers employees the opportunity to participate in a Flexible Spending Account (FSA) program, allowing pre-tax contributions for eligible medical and dependent care expenses. Employees must enroll annually, and unused funds may be forfeited at the end of the plan year, subject to applicable rollover provisions.”
Conclusion
A Flexible Spending Account (FSA) helps employees save money on medical and dependent care expenses by allowing pre-tax contributions. These accounts make healthcare more affordable while reducing taxable income.
For businesses, offering FSAs enhances employee benefits, improves financial wellness, and lowers payroll tax liabilities, making it a valuable addition to a company’s compensation package.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.