Healthcare FSA: What It Is, How It Works, and What It Covers

Out-of-pocket medical costs are climbing faster than paychecks. Employer health insurance costs grew 5.7% year over year in the first quarter of 2026, compared to just 3.4% wage growth over the same period, according to Indeed Hiring Lab's analysis of the Employment Cost Index. Employers are feeling the pressure, too. According to the 2026 Benepass Benefits Benchmarking Report, 51% exceeded their healthcare budgets in the past year. 

A healthcare FSA doesn't change what your health plan covers, but it does change how much of that cost employees actually feel. It's a pre-tax tool that reduces exposure to medical bills without touching your existing plan design, and it's one of the most common benefits HR teams are asked to explain, defend, and administer.

Here is what a healthcare FSA is, how it works, and what HR leaders need to know to set one up correctly.

What is a healthcare FSA?

A healthcare FSA (also called a health FSA or HCFSA) is a pre-tax account that lets employees set aside money from their paycheck to pay for qualified medical, dental, and vision expenses. Employers offer it as part of a broader benefits package, and employees elect a contribution amount each year during open enrollment.

Three mechanics define how a healthcare FSA actually works:

• It's funded through pre-tax payroll deductions. Contributions come out of each paycheck before taxes are calculated, which lowers an employee's taxable income.
• The full annual election is available on day one. Unlike a savings account that builds up gradually, employees can access their entire yearly election as soon as the plan year starts, even though they have not yet made all the payroll contributions.
• The account is employer-owned. If an employee leaves the company, unused FSA funds stay with the employer. That is a key difference from an HSA, which the employee owns for life.

Healthcare FSAs exist because of IRC Section 125, which allows employers to offer a menu of pre-tax benefits through what is known as a cafeteria plan. A flexible spending account is the broader category, and a healthcare FSA is the most common version of it. It's usually the first account HR teams add before rounding out a broader set of modern pre-tax spending accounts like dependent care FSAs, HSAs, and commuter benefits.

2026 healthcare FSA contribution limits and rules

The IRS sets a new contribution limit for healthcare FSAs every year, and HR teams need to update plan documents and employee communications each time it changes.

For 2026, the healthcare FSA contribution limit is $3,400 per employee per plan year, an increase of $100 from the 2025 limit of $3,300, according to the IRS's 2026 inflation adjustments, released through Revenue Procedure 2025-32.

A few rules shape how that limit plays out in practice:

• Carryover. Employers may allow employees to carry over up to $680 of unused funds into the 2027 plan year, up from $660 in 2025.
• Grace period alternative. Instead of a carryover, employers can offer a grace period of up to two and a half months to spend down the prior year's balance. Employers cannot offer both a carryover and a grace period on the same plan.
• Use-it-or-lose-it. Funds not spent by the plan deadline and not protected by a carryover or grace period are forfeited back to the employer.
• Per-employee, not per-household. The $3,400 limit applies to each employee individually. If both spouses have FSA access through separate employers, each can elect up to $3,400.

Contribution limits shift almost every year, and recent legislation has moved other pre-tax limits too. HR teams tracking how the One Big Beautiful Bill affects benefits administration should expect similar year-over-year changes to become the norm rather than the exception.

What does a healthcare FSA cover?

A healthcare FSA covers a wide range of medical, dental, and vision expenses that aren't otherwise reimbursed by insurance.

Eligible medical expenses

Eligible medical expenses include copays, deductibles, coinsurance, prescription medications, and many over-the-counter items like first aid supplies and pain relievers. Employees can also use funds for medical equipment, physical therapy, and mental health services, as long as the expense qualifies under IRS guidelines.

Eligible dental and vision expenses

Dental expenses covered under a healthcare FSA include cleanings, fillings, orthodontics, and other treatments not fully covered by dental insurance. Vision expenses include eye exams, prescription glasses, contact lenses, and corrective surgery like LASIK.

What a healthcare FSA does not cover

A healthcare FSA excludes several categories of spending that employees commonly assume are eligible:

• Health insurance premiums
• Cosmetic procedures
• Gym memberships, unless a doctor provides a letter of medical necessity
• General wellness vitamins and supplements
• Adult or child day care, which falls under a dependent care FSA instead

Clear communication about these exclusions upfront prevents denied claims and frustrated employees later in the plan year.

How a healthcare FSA works step by step

The employee experience follows a consistent sequence, regardless of which administrator runs the plan.

1. Elect a contribution amount during open enrollment. Employees choose how much to set aside for the coming plan year, up to the IRS limit.
2. Funds are deducted from each paycheck, pre-tax. The election is spread evenly across pay periods for the year.
3. The full elected amount is accessible on day one. Employees can use a benefits debit card at the point of purchase or file a reimbursement claim, and the entire annual election is available immediately rather than accruing over time.

Because of the use-it-or-lose-it rule, employees should estimate expenses carefully before electing an amount. Overestimating creates real forfeiture risk, especially without a carryover or grace period in place. Across the 2026 Benepass Benchmarking Report dataset, the median annual HCFSA employee contribution is $1,200, well under the IRS maximum, and 21% of employers have employees who forfeit dollars, with an average forfeiture of $265 among those who do. Forfeiture is real, but it's concentrated among a smaller group of employees who overestimate, not the typical experience. That kind of proactive education around pre-tax benefits tends to pay for itself in reduced forfeitures alone.

Documentation matters throughout the year, not just at enrollment. Employees should save receipts and explanation-of-benefits statements for every FSA purchase in case the plan administrator requests substantiation for an audit.

Healthcare FSA vs. HSA vs. limited purpose FSA

Employees often confuse these three account types, and the differences matter for both eligibility and plan design.

• Healthcare FSA. Available with most health plans, including PPOs. Employer-owned, subject to use-it-or-lose-it with an optional carryover or grace period, and covers medical, dental, and vision expenses.
• HSA. Requires enrollment in an HSA-qualified HDHP. Employee-owned for life, with balances that roll over indefinitely, and covers medical, dental, and vision expenses.
• Limited-purpose FSA. Paired with an HSA. Employer-owned, subject to the same use-it-or-lose-it rules as a healthcare FSA, but restricted to dental and vision expenses only.

A limited-purpose FSA restricts spending to dental and vision expenses so that it doesn't interfere with HSA eligibility. That distinction matters because employees enrolled in an HDHP with an HSA cannot also enroll in a full healthcare FSA. This is one of the most common enrollment errors HR teams see, and clear plan communications at open enrollment can prevent it: employees who want both an HSA and FSA-style coverage need the limited purpose version, and the full healthcare FSA isn't an option for them.

How HR leaders can set up and administer a healthcare FSA

Offering a healthcare FSA comes with specific administrative requirements on the employer side.

• Establish it under a Section 125 cafeteria plan, with a written plan document that spells out eligibility, contribution limits, and forfeiture rules.
• Work with a qualified third-party administrator (TPA) to handle enrollment, claims processing, and card issuance.
• Run open enrollment communications that clearly state the current-year contribution limit, carryover or grace period policy, and covered expense categories.
• Complete annual nondiscrimination testing to confirm the plan doesn't disproportionately favor highly compensated employees, a requirement under Section 125.

Benepass administers healthcare FSAs as part of a broader pre-tax and flexible benefits platform, giving employees one card and one place to manage every spending account instead of juggling separate logins and cards for their FSA, commuter benefits, and other pre-tax programs. According to the 2026 Benepass Benefits Benchmarking Report, healthcare FSA card spend represents 79% of total spend, as employees grow more comfortable using their benefits card at the point of sale instead of filing paper claims. 

That shift toward card-first spending is worth building into your rollout plan. The easier it is for employees to use their FSA in the moment, the less likely funds are to sit unused until they are forfeited. HR teams building out a full pre-tax and flexible benefits strategy, not just a standalone FSA, tend to see stronger utilization across the board because employees only have to learn one system.

Ready to See It in Action?

If you're building out a comprehensive employee benefits strategy and want fewer vendors, less manual administration, and a single card employees actually use, book a demo to see how Benepass brings pre-tax and flexible benefits together on one platform.

Frequently asked questions about healthcare FSAs

Can an employee contribute to both a healthcare FSA and an HSA?

No, not to a full healthcare FSA. Employees enrolled in an HSA-qualified HDHP can pair their HSA with a limited-purpose FSA instead, which covers only dental and vision expenses and preserves HSA eligibility.

What happens to unused healthcare FSA funds at the end of the plan year?

Unused funds are forfeited unless the employer offers a carryover of up to $680 into the following plan year or a grace period of up to two and a half months to spend down the balance. Employers can offer one option or neither, but not both.

Can HR teams change FSA contribution limits mid-year?

Employers set their own plan limit at or below the IRS maximum, and that limit generally cannot change once a plan year begins. Employees can change their individual election mid-year only if they experience a qualifying life event, such as marriage, divorce, or the birth of a child.

A healthcare FSA is one piece of a much larger pre-tax strategy, and how well it works often depends on how it's administered alongside everything else in your benefits stack.