Flexible Spending Account (FSA)

Employees choose how much to contribute at the start of the plan year, up to annual limits, and the amount is deducted from their pay before income and payroll taxes. They can then use the account to pay for eligible expenses, such as deductibles, copayments, prescriptions, glasses or, with a dependent care FSA, childcare.

For example, an employee who expects to spend about 1,500 on medical costs during the year might contribute that amount to a health FSA, reducing their taxable income and effectively paying those costs with pre-tax money.

The key drawback is the use-it-or-lose-it rule. Money not spent by the end of the plan year is generally forfeited, although employers may allow a limited carryover or a short grace period. Unlike health savings accounts, FSAs usually stay with the employer if the employee leaves, and they cannot be invested.

FSAs suit people who can predict their expenses fairly accurately. A health FSA can be used with most types of health plan, unlike an HSA, which requires a high-deductible plan.