Flexible spending account
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A flexible spending account is a tax advantaged savings account set up through an employer in the United States to allow tax free savings for qualified medical or dependent care expenses. They are similar to the Health savings accounts (HSA)'s that are available to self employed persons or some small businesses, but they are less flexible in many ways.
There are actually two different FSA accounts available. One is for qualified medical expenses and the other is for dependent care expenses. Both allow a maximum deferral amount of $5,000 total for a family, and they can both be utilized concurrently.
The Flexible spending account allows money to be deducted from an employee's paycheck pre-tax and then spent for qualified expenses tax free. The drawback is that the money must be spent within the calendar year. Any money left unspent at the end of the year is lost to the employee. This is known as the "use it or lose it" provision. The amount deducted from each paycheck must also remain the same throughout the year unless certain events such as birth of a child or death in the family occur. Despite these inflexibilities, flexible spending accounts are very common due to their unusual advantage of allowing money for medical expenses to be spent tax free if all the conditions are met.
For example if a person in the 28% Federal marginal bracket and an example 4% state tax, along with the FICA and Medicare taxes of typically 7.625%, for a total of almost 40%, $2,000 deducted and put into an FSA for health or dependent care would result in almost $800 in tax savings. If this example person had not utilized the FSA, they likely would not have been able to deduct this $2,000 expense because it would not have met the 7.5% Of AGI threshold needed to be able to deduct it on their federal tax return. If the same person had $5,000 in dependent care expenses, and put that much into their dependent care FSA, the tax savings would be $2,000.
Because of the inflexibility, especially the "use it or lose it" provision, the only money that should be deferred into flexible spending plans is for highly predictable expenses, that can be known with near certainty that they will be incurred in the given year.