Many company healthcare plans offer flexible spending accounts (FSAs), but employees are not always aware of all the different flexible spending account rules. "Use it or lose it" is one policy that many people learn the hard way. Other common flexible spending account rules affect how much money can be contributed and what that money can be spent on. There are also major differences between medical expense FSAs and dependent care FSAs.
The most important of the flexible spending account rules is "use it or lose it." This means that the money in an account is only good for the defined coverage period. For example, if the period is outlined as 1 January to 31 December of a certain year, any money in the account that is not spent by the end of December is automatically forfeited. Unfortunately, most flexible spending account rules state that the coverage period can also come to an end upon termination of employment, even if the termination was issued by the employer. Some companies provide their employees with a grace period that extends the coverage period for several weeks or months.
Once an employee has elected to contribute a certain amount, that amount may not be changed throughout the year, except in certain qualifying events. Some of these occasions include the death of a spouse or the birth of a child. Money in an FSA may not be withdrawn except through purchases of allowable items or procedures.
What qualifies as a legitimate purchase is where flexible spending account rules can get tricky. Most people are aware that money from their FSA can be used toward deductibles, copayments, and prescription drugs, but don't realize that things like dental care and laser eye surgery also may qualify. As of 2011, over-the-counter medications can no longer be paid for from an FSA without a doctor's prescription.
On the other hand, some things that seem as if they should qualify, such as diapers and teeth whitening, actually do not. Most healthcare plans will provide a list of allowable medical expenses, as well as a list of items that are not permissible. The general rule of thumb is that allowable items for an FSA are also accepted for medical tax deductions.
FSAs can also be established for dependents who live with the employee, to pay for services such as child care and senior care. These dependents must be claimed as official dependents on the employee's federal tax return. A major difference between medical expense FSAs and dependent care FSAs is that the former is pre-funded, meaning that employees can spend the annual amount on the very first day of the coverage period. Meanwhile, dependent care money can only be withdrawn as it is deposited, for example in increments of 1/26 if an employee receives a bi-weekly paycheck.