What is a Flexible Spending Account?

You want to help your team with healthcare costs. But getting started can feel like a challenge.

You’re in good company. Many business owners want to offer healthcare benefits that matter to their employees. But figuring out the options and the tax rules can feel like a maze. 

Here’s a viable solution to consider: Flexible Spending Accounts (FSAs) can help your team and your bottom line. FSAs let employees use pre-tax dollars for eligible healthcare costs. That stretches their money further and lowers your payroll taxes. It’s a win for everyone and easier to set up than you might think. 

Let’s break down what FSAs are, how they work, and what you need to know to offer them well. 

What is an FSA, and how does it work? 

A Flexible Spending Account (FSA) is an employer-sponsored account. It lets employees pay for out-of-pocket medical costs with pre-tax dollars. 

Here’s what employees can usually pay for: 

• Copays and deductibles 
• Prescription medications 
• Over-the-counter drugs (sometimes with a prescription) 
• Glasses, contacts, and eye exams 
• Dental treatments and orthodontics 
• Medical supplies like crutches or bandages 

Here’s how it works: 

Employees choose how much to contribute for the year, up to IRS limits. They get access to the full amount on day one, even though the money comes out of their paychecks over the year. When they pay for eligible expenses, they submit receipts to the FSA administrator for reimbursement. 

One catch: If they don’t spend the money by the deadline, they lose it. More on that next. 

How do FSAs save money for employees and employers? 

For employees: 

FSAs use pre-tax dollars. That means they pay less in federal income, Social Security, and Medicare taxes. This can add up to real savings, often hundreds of dollars each year. FSAs also bring predictability. Instead of surprises, there’s a dedicated fund to cover common costs. 

For employers: 

You don’t pay payroll taxes on employee FSA contributions. Every dollar employees set aside lowers your tax bill. FSAs make your benefits package more appealing without a huge cost increase. 

What’s the “use-it-or-lose-it” rule, and how can you help employees avoid losing funds? 

If employees don’t spend their FSA money by the plan year’s end, they lose it. 

But you have two ways to help: 

• Grace period: Give employees up to 2.5 more months to use their funds
• Carryover: Let them roll over up to a set amount (updated each year) into the next plan year

You can choose one option, not both. Clear communication helps employees plan ahead and avoid losing money. 

To help employees use their FSAs: 

• Encourage them to track expenses during the year
• Send reminders as deadlines approach
• Share examples of what counts as eligible expenses; many employees don’t realize how much they can use FSAs for

How do I set up an FSA program? 

It’s easier than it sounds, especially if you partner with a trusted administrator. Here’s what to do: 

• Choose an administrator
  You can handle it yourself, but most small businesses work with a third-party provider. They handle compliance, reimbursements, and employee support.  
• Design your plan
  • Decide what type of FSA you’ll offer: health FSA, dependent care FSA, or both
  • Decide if you’ll contribute funds
  • Set your plan year and choose either a grace period or carryover
• Stay compliant
  FSAs have to follow IRS and ERISA rules. Your administrator can help with the paperwork and reporting.  
• Communicate with your team
  Make sure employees understand how to enroll, what’s covered, and how to use their funds  
• Integrate with payroll
  FSA contributions must be deducted pre-tax and shown correctly on pay stubs and year-end tax forms

FSAs, HSAs, and HRAs: what’s the difference? 

FSAs aren’t the only option. HSAs (Health Savings Accounts) and HRAs (Health Reimbursement Arrangements) also help cover healthcare costs. 

Here’s how they compare: 

Which is right for your team? 

If you offer a High Deductible Health Plan (HDHP), employees may like HSAs. HSAs roll over and stay with them if they leave. But FSAs can still be valuable. They’re helpful for employees who want to save for expenses insurance doesn’t cover or for those who aren’t HSA-eligible. 

Some employers offer both FSAs and HSAs or HRAs. It depends on what you want to achieve with your benefits plan. 

Common Mistakes to Watch Out For 

Even with the best intentions, mistakes can happen. Here are some common problems and some proactive ides to help: 

❌ Employees contribute more than they need. 
✅Help them plan realistic contributions. 

❌ Confusion about what’s covered. 
✅ Provide a simple, clear list of eligible expenses. 

❌ Missed deadlines. 
✅ Use calendar reminders and send helpful nudges. 

❌ Mixing up FSAs, HSAs, and HRAs. 
✅ Provide clear explanations and real-world examples. 

Your FSA administrator can help. They usually have educational resources and tools to guide your employees. 

The Bottom Line

If you want a cost-effective way to support your team and lower your taxes, an FSA is worth considering. 

FSAs are simple to set up, give your team real savings, and make your benefits package stronger. That’s especially important in a tough hiring market. 

Here’s what to do next: 

• Think about how FSAs fit with your benefits strategy
• Talk to your payroll provider or benefits consultant about setting up a plan
• Ask your team what they’d like help with most

A well-run FSA plan can make a big difference. It helps your people feel supported and makes every dollar count.