You can use a flexible spending account to pay for qualified medical expenses, but not to pay health insurance premiums. The Internal Revenue Service defines those medical costs that qualify. Your contributions to an FSA are made pre-tax, saving you money on some otherwise taxable income. Your employer may also contribute to your FSA with pre-tax dollars, which are also excluded from your gross income.
Flexible Spending Accounts
Employers create FSAs, also called flexible spending arrangements, as components of cafeteria plan benefits, allowing employees to choose from a menu of benefit options. Employees set aside some of their wages, before taxes, to pay qualified medical expenses. FSAs cannot be used to pay health insurance premiums, but they are designed to augment health plans. You can pay deductibles and co-pays, as well as for treatments and prescription drugs excluded from coverage by your health insurance.
Health Insurance Premiums
FSAs are authorized by the IRS to help employees fill in gaps, resulting in out-of-pocket expenses, in the health insurance coverage offered by their employers. The IRS states that "you cannot receive distributions from your FSA for ... amounts paid for health insurance premiums." This IRS prohibition also applies to premiums due for long-term care insurance coverage or expenses incurred for long-term care.
Qualified Medical Expenses
Those medical expenses for which you can use your FSA are those noted in your employer FSA plan. In most cases, qualified medical expenses are costs for medical and dental treatment that are tax-deductible. The IRS explains and specifies these qualified expenses in its Publication 502, Medical and Dental Expenses. The IRS does not consider most over-the-counter medicine, with the exception of insulin, as a qualified medical expense. However, along with prescription drugs, the IRS allows FSA withdrawals if you get a prescription for an over-the-counter medication.
Along with the prohibition of paying your health insurance premiums, FSAs also come with another potentially costly feature. Commonly called the "use it or lose it" clause, it means you forfeit unused money in your FSA at the end of the plan year. Your employer may use forfeited funds to offset administrative costs of the plan. Employers may also credit excess funds to employees' FSAs for the following plan year if they categorize them as "experience gains" and allocate money on a "reasonable and uniform" basis to all participants in the FSA plan.
Unfortunately, self-employed people are not eligible to create an FSA, according to the IRS. They can deduct their health insurance premiums, within any then-prevailing limitations imposed by the IRS in current tax years. However, self-employed people cannot legally set up a formal FSA with pre-tax dollars.
FSA and Health Insurance
Although you cannot use your FSA to pay health insurance premiums, you can use this account to pay all qualified medical expenses not covered by your health insurance. Along with paying insurance deductibles and co-pays, you can use your FSA for other medical expenses. For example, if your employer offers traditional "major medical" insurance, even covered surgeries may reimburse only 80 percent of their cost, requiring you to pay 20 percent of medical fees. Your FSA money can bridge this gap.