What Are FSA Funds? How They Work and What They Cover

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If your employer mentioned an FSA during open enrollment and you glossed over it, you are not alone. Many workers are uncertain about what are FSA funds and how they differ from their regular health insurance. In simple terms, FSA funds are pre-tax dollars set aside from your paycheck specifically to pay for qualified medical expenses. They reduce your taxable income and can save many people roughly 25% to 40% on healthcare costs they are already paying out of pocket, depending on their tax bracket. This article is general educational information, not tax or financial advice; confirm the details for your situation with your FSA administrator and a qualified tax professional.

According to the Bureau of Labor Statistics, a large share of workers at medium and large employers have access to a healthcare FSA. Yet many do not participate, often because they do not fully understand how the money works or fear losing unspent funds.

FSA Funds: The Basics

FSA funds are money that your employer withholds from your gross pay before calculating federal income tax, state income tax (in most states), Social Security tax, and Medicare tax. The money goes into a special account administered by a third-party benefits company such as HealthEquity, WEX, Optum Financial, or another administrator. You then draw from this account throughout the year to pay for eligible healthcare expenses.

The critical concept is the pre-tax treatment. If you earn $60,000 and contribute $3,000 to your FSA, your taxable income drops to $57,000. You still have access to the $3,000 for medical spending, but you never pay income tax or payroll tax on it, so the money effectively stretches further than after-tax dollars. Your exact savings depend on your tax bracket and state. For the mechanics of how this works paycheck to paycheck, see our detailed FSA explainer.

Where FSA Funds Come From

You elect your contribution amount during your employer’s annual open enrollment period, typically in the fall for a January 1 plan year start. The 2026 IRS maximum for health FSA salary-reduction contributions is $3,400 per employee (up from $3,300 in 2025), set under IRS Revenue Procedure 2025-32; confirm the current figure with your plan, since the IRS adjusts it most years. Your employer deducts the amount evenly across your paychecks throughout the year. Some employers also contribute to employee FSAs as part of their benefits package, though this is less common, and any employer contribution may affect your own limit.

Once elected, your contribution amount is generally locked for the plan year. You can typically change your election mid-year only if you experience a qualifying life event such as marriage, divorce, birth of a child, adoption, or a change in your spouse’s employment status that affects their benefits. Plan your election carefully by estimating your expected out-of-pocket medical costs for the coming year, and check your specific plan’s rules, which can vary.

What FSA Funds Can Pay For

FSA funds cover a wide range of medical expenses defined by the IRS under Section 213(d) of the Internal Revenue Code and detailed in IRS Publication 502. Major categories include medical services like office visits, specialist appointments, lab work, imaging, and hospital stays. Prescription drugs are covered at any pharmacy. Dental services including cleanings, fillings, crowns, orthodontics, and dentures generally qualify. Vision care including exams, glasses, contact lenses, and laser eye surgery is typically covered. Other commonly eligible items include copays, deductibles, and coinsurance; bandages and first-aid supplies; blood pressure monitors and diabetic testing supplies; and eligible medical equipment.

Since the CARES Act of 2020, over-the-counter medications no longer require a prescription to be FSA eligible. This includes common products like acetaminophen (Tylenol), ibuprofen (Advil), antihistamines (Zyrtec), antacids, and cold and flu remedies. Menstrual care products – tampons, pads, liners, cups, and similar – were also permanently added to the eligible expense list. Sunscreen with SPF 15 or higher generally qualifies as well. Because eligibility lists are periodically updated, check Publication 502 or your administrator’s eligible-expense list before assuming an item counts.

What FSA Funds Cannot Pay For

Certain categories are generally excluded. Cosmetic procedures performed solely for appearance, such as teeth whitening, purely cosmetic surgery, and hair transplants, typically do not qualify. Health club or gym membership dues are generally not eligible. Insurance premiums, including most health insurance and long-term care insurance premiums, usually cannot be paid with health FSA funds. Personal care items like toothbrushes, shampoo, and general-purpose vitamins and supplements taken for overall wellness are typically excluded.

The gray area comes with items that can serve both medical and personal purposes. Products like air purifiers, mattresses, and special shoes may qualify only when prescribed for a specific medical condition, often with a Letter of Medical Necessity or other supporting documentation. When in doubt, check IRS Publication 502 or contact your FSA administrator before making a purchase, since claiming an ineligible expense can create tax headaches later.

The Use-It-or-Lose-It Rule

The most important thing to understand about what are FSA funds is that they generally do not carry over freely from year to year. If you do not spend your balance by the end of the plan year, you can forfeit the remaining money. Your employer may offer one of two IRS-allowed exceptions: a grace period of up to 2.5 months after the plan year ends to spend down the balance, or a carryover provision that lets you roll over up to a capped amount into the next year (the carryover limit for amounts rolling into 2026 is up to $680; verify the current figure with your plan). Not all employers offer either option, and no employer can offer both a grace period and a carryover for the same plan.

This forfeiture rule makes accurate planning essential. Underestimating your FSA election means you miss out on tax savings for expenses you end up paying with after-tax dollars. Overestimating means you either scramble to spend down the balance or lose money outright. Review your previous year’s medical receipts to estimate a realistic election amount, and check your plan’s specific grace-period or carryover terms so you know your real deadline.

How to Access Your FSA Funds

Most FSA administrators provide a debit card that links directly to your FSA account. This card works at pharmacies, doctor’s offices, hospitals, dental clinics, and many retailers for eligible purchases. When the card is declined or you pay out of pocket, you can submit a manual reimbursement claim through your administrator’s website or mobile app. Keep receipts and explanations of benefits for all FSA-related expenses, because your administrator may request documentation to substantiate a purchase, and good records matter if your tax return is ever examined.

One unique feature of a health FSA is front-loading: your entire annual election is generally available on the first day of the plan year, even though you have contributed only a fraction through payroll deductions. If you elect $3,400 and need a $2,000 dental procedure in January, you can typically use your FSA to pay for it immediately. This is different from an HSA, where you can only spend what you have actually deposited so far. For more on the pre-tax mechanics, see our guide to the pre-tax nature of FSAs.

Frequently Asked Questions

Are FSA funds taxed?

Generally, no. FSA contributions are deducted from your pay before federal, most state, Social Security, and Medicare taxes are calculated, and withdrawals for qualified medical expenses are tax-free. You typically do not report FSA contributions or reimbursements on your personal tax return. Confirm the treatment in your state with a tax professional, and learn more about the pre-tax nature of FSAs.

Can I use FSA funds for my family?

Yes. Health FSA funds can generally cover qualified medical expenses for you, your spouse, and your tax dependents, regardless of whether they are enrolled in your employer’s health plan. Check your plan’s definition of an eligible dependent if you are unsure.

What happens to my FSA if I get fired or quit?

Typically, you lose access to remaining FSA funds when employment ends. You can usually be reimbursed for eligible expenses incurred before your termination date, but the account is generally closed after that. COBRA continuation for health FSAs is sometimes available but is often not cost-effective; ask your administrator about your options.

What is the FSA contribution limit for 2026?

The 2026 health FSA salary-reduction limit is $3,400 per employee, with a carryover of up to $680 if your employer offers a carryover (rather than a grace period). These figures are set by the IRS and adjust most years, so verify the current numbers with your plan administrator before you elect.

How much should I contribute to my FSA?

Base your election on your expected out-of-pocket medical costs for the year. Add up anticipated copays, prescriptions, dental work, vision expenses, and any planned procedures. If you are unsure, start conservative to reduce the risk of forfeiture. You can increase your election the following year if you find you are paying significant amounts out of pocket.

The Bottom Line

FSA funds are simply your own money, taken from your paycheck before taxes, and earmarked for medical spending. The tax savings are real and meaningful. The trade-off is the use-it-or-lose-it deadline and the requirement to plan ahead. If you have predictable medical expenses – and most people do – an FSA is one of the easiest ways to reduce your tax burden while covering costs you would pay regardless. Understanding what are FSA funds and how to use them effectively is a basic financial literacy skill that can pay for itself every year you participate – just confirm the current limits and your plan’s specific rules before you enroll.

Sources

• IRS – Publication 502 (Medical and Dental Expenses) and Section 213(d) (irs.gov)
• IRS – Revenue Procedure 2025-32, 2026 health FSA limit and carryover (irs.gov)
• CARES Act (2020) – OTC medication and menstrual product eligibility (congress.gov)
• U.S. Bureau of Labor Statistics – employee benefits access (bls.gov)