A Health Care Spending Account (HCSA), often referred to as a Flexible Spending Account (FSA), is an employer-sponsored benefit that allows employees to set aside money for qualified medical expenses on a pre-tax basis. This financial tool helps individuals manage out-of-pocket healthcare costs throughout the plan year. By contributing to an HCSA, participants reduce their taxable income, offering an immediate tax advantage to cover predictable health, dental, and vision expenditures not fully covered by a standard health insurance policy.
Defining the Health Care Spending Account
An HCSA is a tax-advantaged account established under an employer’s Section 125 Cafeteria Plan, permitted by the Internal Revenue Code (IRC). It is primarily funded through employee salary reduction contributions, which are deducted from each paycheck before income taxes are calculated. This pre-tax funding maximizes the purchasing power of the funds.
Employers may also contribute to the HCSA, though the primary source of funding is typically the employee’s pre-tax payroll deduction. The funds reimburse employees for eligible healthcare costs incurred by themselves, their spouse, or their eligible dependents. Qualified medical expenses are defined by the IRC and include a broad spectrum of services and products.
Qualified medical expenses include:
- Co-payments, deductibles, and co-insurance amounts.
- Prescription medications.
- Eyeglasses and contact lenses.
- Certain dental treatments (e.g., cleanings, fillings, and orthodontics).
- Over-the-counter medications and menstrual care products (now eligible without a prescription).
Key Rules Governing Usage and Funds
The utility of an HCSA is shaped by specific Internal Revenue Service (IRS) regulations. A defining feature is the “use-it-or-lose-it” rule, which dictates that most funds must be spent within the plan year. Any money remaining is generally forfeited to the employer, preventing the account from functioning as a long-term savings vehicle.
To provide flexibility, employers can offer one of two limited exceptions. The first is a grace period, allowing participants an additional two and a half months to incur eligible expenses using the prior year’s funds. Alternatively, a plan may permit a limited carryover amount to roll into the next plan year; for 2025, this maximum carryover is $660.
The IRS sets an annual limit on employee contributions through salary reduction; for 2025, the maximum is $3,300. HCSAs are generally non-portable, meaning the funds belong to the employer’s plan and cannot be taken if the employee changes jobs. Claims for reimbursement must be substantiated with documentation, such as receipts, to ensure funds are used only for qualified medical expenses.
Contrasting HCSAs with Health Savings Accounts (HSAs)
While both the HCSA and the Health Savings Account (HSA) offer tax-advantaged ways to pay for qualified medical expenses, they operate under different regulatory frameworks. A primary distinction lies in eligibility: an HSA requires the participant to be enrolled in a High Deductible Health Plan (HDHP). In contrast, an HCSA (FSA) does not have any prerequisite health plan enrollment.
The most notable difference is the treatment of unused funds. HSA funds are fully portable, owned by the individual, and automatically roll over, allowing them to accumulate and be invested over time. The HCSA, conversely, is a spending account subject to the strict annual “use-it-or-lose-it” rule, designed for immediate healthcare needs rather than long-term savings.
Contribution limits also differ significantly, reflecting the savings-oriented nature of the HSA. For 2025, an individual with self-only HDHP coverage can contribute up to $4,300 to an HSA, and those with family coverage can contribute up to $8,550. Individuals aged 55 or older can make an additional $1,000 catch-up contribution. The HCSA limit is lower and fixed per employee, regardless of coverage tier.