Why Your FSA Could Lose You Money

How do FSAs work?

When you enroll in a healthcare FSA that your employer offers, you can defer pretax income to use for approved health expenses. According to IRS rules, the maximum pretax income you can defer from your paycheck to your FSA in 2023 is $3,050. The IRS changes the amount in most, but not all, years. 

Here are some pertinent FSA facts you should understand: 

• Employers can match FSA contributions. Your FSA can accumulate more than the maximum pretax income annually if your employer matches your contributions. This arrangement is the same as 401(k) matching plans that the best employee retirement plans usually provide.
• You can spend FSA funds on approved expenses. You can spend your FSA funds on over 10,000 products, often through an attached debit card. Some of these products are everyday purchases, such as bandages, at-home COVID tests and over-the-counter (OTC) pain relievers. However, for these items to qualify for FSA coverage, you may buy them only in quantities reasonable for short-term use. You can also use your FSA funds toward glasses, vaccines, prescriptions, acupuncture and other non-OTC medical products. Additionally, you can sometimes use FSA funds to cover deductibles and copays.
• You may lose your FSA if you leave your job. Notably, because an FSA is part of an employee benefits package, you lose access if you leave your job. The only exception is if you opt in to COBRA insurance to keep yourself insured upon parting ways with the employer. However, opting in to COBRA is necessary only if you don’t immediately have new employment lined up or become a freelancer. Additionally, only employers with over 20 employees can offer COBRA to departing employees. In many cases, leaving your job ultimately means losing your FSA.

The key appeal of FSAs is that you pay no income taxes on your FSA contributions. This can save you serious money. Additionally, you’ll always have funds set aside for healthcare expenses. Financially, it’s a win-win — if you go about it correctly.

Why can FSAs lose you money?

The catch with FSAs is that the IRS requires you to spend all the money you’ve contributed by the end of your plan year. Typically, this deadline is Dec. 31 of the calendar year. Any money remaining in your account after this date goes back to your employer. 

This FSA rule is why, in 2020, 48 percent of employees with FSAs lost money on their accounts, with a $408 average loss, according to the Employee Benefit Research Institute. Across all employees, this loss totaled $4.2 billion. 

However, with the proper steps and your employer’s help, you can avoid losing money on your FSA.

How can you avoid losing money on your FSA?

Although employees collectively lose billions of dollars annually on their FSAs, you don’t have to be one of them. Here’s how you can avoid losing money on your FSA.

1. Ask your employer to implement FSA rollovers or a grace period.

IRS rules allow employers to loosen up the FSA year-end deadline a bit. 

“When employers choose to offer an FSA, they have the choice to offer a grace period or rollover under their plan,” said Mark Haessly, managing director of product management at HSA Bank. “But, per IRS rules, they cannot have both.”

• FSA grace periods: Haessly explained that during grace periods, employees can spend their previous FSA plan year’s funds between Jan. 1 and March 15 of the current plan year. 
• FSA rollovers: For 2023, rollovers limit your access to $610 of the previous year’s funds that you can use anytime during the current year. Haessly noted that the rollover maximum is indexed for inflation, so it typically increases yearly.

You can ask your employer to implement rollovers or a grace period to minimize your FSA losses. Without your employer formally going through the steps to do so, these options are unavailable. Once you have these options, you’ll likely find it much easier to use all of your FSA funds.

“Although slightly different, each of these options helps employees spend any unused FSA dollars to avoid forfeiting them,” Haessly said.

2. Opt in to reminders and notifications about FSA deadlines.

In nearly all cases, you’ll access your FSA via an online portal. You can turn on notifications within these platforms to stay abreast of upcoming FSA deadlines. Taking action based on these notifications can minimize or eliminate your financial losses.

“Employees should sign up for any email or text alerts that their administrator may offer in their web portals so they are aware of any important reminders,” Haessly advised, adding that reminders about end-of-year spending deadlines and filing dates are particularly crucial. 

Bryttani Graddick, CEO and founder of Talented Teams Consulting, agreed with Haessly but put the onus on employers rather than employees.

“My team emails all FSA participants with active FSA dollars above the rollover limit once each quarter,” Graddick said. “These reminders help these dollars stay front of mind for the employee and reduce the complaints at year-end or after the grace period.” Graddick added that it’s also helpful to send quarterly emails reminding employees to log in and check their balances. “Yes, it’s a little more work, but employees appreciate this assistance,” she said.

3. Put aside the right amount in your FSA.

Avoiding excess funds in your FSA is crucial. But what is the right amount to put aside in an FSA?

“I would advise employees to look back at their medical expenses from the prior year to gauge what they might spend in the coming plan year, especially if they had regularly occurring treatments or prescriptions,” Haessly said. “Additionally, employees should anticipate any future medical expenses they may need and factor those in as well. For example, if someone wears eyeglasses or contact lenses, these expenses are much more predictable, which helps optimize their contributions.”

No matter what, however, determining the precise amount to contribute is tricky, Haessly said. He recommended using an online FSA calculator to make a reasonable estimate.

4. Track your FSA spending.

Just like tracking business expenses, tracking your FSA spending is an excellent way to ensure you use all account funds by the plan year’s end. This might sound tedious, but the online FSA portal makes it easy.

“Most employees, depending on the administrator, will have access to an online portal, where they can view their accounts, submit expenses for reimbursement, as well as track their FSA spending,” Haessly explained. “And, for employees who don’t always have access to a computer, many administrators offer mobile apps to accommodate the growing number of smartphone users, allowing users to easily access these resources.”

5. Keep and upload FSA expense receipts.

Technically, under IRS regulations, you must provide receipts for most expenses you cover through your FSA. While it’s relatively unlikely that the IRS will actually contact you or your employer to request these receipts, it’s still a best practice to keep them. In addition to being good for compliance, it’s a great way to track your FSA funds. Keeping tabs on your spending can help you deplete your funds before your plan year ends. 

Haessly noted that some expenses don’t require receipts to be FSA-eligible. These include prescriptions picked up in person at a national pharmacy retailer and, in some cases, copays and recurring medical expenses. Nevertheless, you’ll likely find it helpful to keep receipts for these purchases. When you know how much you’ve spent on each FSA-eligible purchase, you’ll know you’re on your way to using your money on time.

FSAs save you money when you use them correctly

Wasting money must be avoided at all costs, especially because many of today’s workers are drowning in debt. Working with your employer to set up FSA grace periods or rollovers and staying on top of deadlines can nip monetary losses in the bud. It’s also crucial to allocate reasonable amounts to your FSA and to track your spending, especially through receipts. 

Taking these steps will help you do more than avoid losing money. Because the funds you set aside don’t have income tax levied, you’re effectively increasing your take-home pay when you properly manage your FSA. With the right safeguards in place, you can truly make the most of your FSA.