FSA stands for a flexible spending account, also known as a cafeteria plan or a flex plan. With this account, an employee can set aside a certain amount of their income to pay for expenses such as medical care. They do not need to pay income tax on the money covered by the FSA, but the money can only be used to pay for expenses already specified in the contract. Usually, these expenses cover areas not already covered by medical insurance, such as prescription drugs and medical supplies, dietary supplements, vitamins, and over-the-counter medication, psychiatric care, dental services, and optical care.
While the program is beneficial to many employees who would otherwise have to pay income tax over these necessities, one of the drawbacks of the plan is the “use it or lose it” rule. At the beginning of the year, an employee has set aside a certain amount of their income in the flexible spending account; however, the terms of the contract specify that the employee must spend the money by the end of the coverage period. This coverage period typically lasts one calendar year, i.e. January of one year to the January of the next. However, some employers’ flexible spending account contracts have a grace period attached to the end of the coverage period, so that the coverage period lasts from the January of one year to the March of the next.
If there still remains money in an employee’s flexible spending account after the coverage period has ended, this money will no longer be accessible by the employee. Instead, the money usually goes toward the FSA administration costs, back toward the employer. The “use it or lose it” rule can be disadvantageous towards many FSA participants if their predicted costs do not match up with their own needs. Recently there have been movements to allow users of flexible spending accounts to withdraw funds from their FSA at the end of the year in order to avoid forfeiting the money, since the risk of the “use it or lose it” rule can deter non-participants from signing up for an account, and can also create a risk for participants who currently use a plan.