Flexible Spending Account as an Employee Benefit

A commonly used method of funding cafeteria plans is the flexible spending account (FSA). An FSA allows you to contribute pretax dollars to an account that may later be used to reimburse you for qualified expenses. The pretax dollars that you use to fund the account usually come from a salary reduction program. If you wish to enroll in an FSA, you must do so once a year for a specified amount of dollars.

Example(s): Jack participates in his employer's cafeteria plan and contributes $100 a month to a health-care FSA and $200 a month to a dependent care FSA. As Jack incurs medical and dependent care expenses, he submits his claims to his employer, who then pays the claims from both of his FSAs.

Refundable versus forfeitable

There are two types of FSAs: refundable and forfeitable. If an FSA is refundable, it does not provide you with nontaxable benefits, since you will receive benefits even if you do not incur any qualifying expenses. If an FSA is forfeitable, you will be able to exclude the reimbursements you receive from the account from your taxable income. However, under a forfeitable FSA, you will be unable to carry over any contributions that you do not use from one plan year to the following plan year. As a result, you must use all of the amounts that you contribute to a forfeitable FSA or your benefits are lost. In other words, you use it or lose it. This concept of use it or lose it is one of the major drawbacks to a forfeitable FSA. However, many employees feel that the tax savings they can receive from a forfeitable FSA substantially outweigh the risks of losing any contributions that they do not use.

Example 1: Diane participates in her employer's cafeteria plan, which is funded by a forfeitable FSA. Diane wants to use the account for the reimbursement of her qualified medical expenses. During the past plan year, Diane has contributed $2,000 to the account but only sought reimbursement for $1,000 in qualified medical expenses. As a result, Diane will lose the remaining $1,000 because she cannot carry over the benefits she did not use to the following plan year.

Health-care flexible spending accounts

Your employer can reimburse you for medical and dental expenses by using contributions made to a health-care FSA. Expenses that your employer can reimburse you for include the annual deductibles for your health-care plan, as well as any medical and dental expenses that your health plan does not cover.

Dependent care flexible spending accounts

Dependent care FSAs pay for the care of dependent children under the age of 13 by a baby-sitter, day care center, or a before-school/after-school program. The account can also be used to pay for the care of a disabled spouse, parent, or child over the age of 12.

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