FSA Explained: How It Works and the "Use It or Lose It" Rule

A flexible spending account (FSA) lets you pay for many medical costs with money that isn't taxed. It can save you real money. But it has one big catch: if you don't spend the money in time, you can lose it. Here's how to use an FSA wisely.

What is a health FSA?

HealthCare.gov describes an FSA as an arrangement through your employer that lets you pay for many out-of-pocket medical expenses with tax-free dollars. Examples include copays, deductibles, prescriptions, insulin, and medical devices.

Key facts from IRS Publication 969:

• FSAs are set up by employers. Self-employed people can't have one.
• You choose how much to put in at the start of the plan year. Your employer takes it out of your paychecks, usually a little each payday.
• You don't pay federal income tax or employment taxes on the money you put in.
• Your employer may add money too, if the plan allows.
• You can usually change your amount only if the law and your plan allow it (for example, after certain life events).

How much can I put in?

The IRS sets a yearly maximum. Your employer can set a lower one.

• 2026: up to $3,400 (IRS Revenue Procedure 2025-32).
• 2027: As of November 1, 2026, the IRS had not yet published the official 2027 health FSA limit. It usually announces it in the fall. Check your enrollment materials or IRS.gov for the final number before you choose your 2027 amount.

The nice surprise: your full amount is available early

IRS Publication 969 says you must be able to get the full amount you elected for the year at any time during the coverage period, no matter how much you've paid in so far.

Made-up example: Rosa elects $1,200 for the year, or $50 per paycheck. In February she needs a $900 dental filling. Even though she's only put in about $150 so far, her FSA can reimburse the full $900.

The catch: "use it or lose it"

IRS Publication 969 says FSAs are generally "use-it-or-lose-it" plans. Money left at the end of the plan year generally can't be carried over, and your employer isn't allowed to refund it to you.

But your employer may offer one of these two safety valves (not both):

Option 1: Grace period

The plan can give you up to 2½ extra months after the plan year ends. Medical costs you have during that time can be paid from last year's leftover money.

Option 2: Carryover

The plan can let you carry over a limited amount of unused money into the next plan year. Anything above that amount is lost.

• From a 2026 plan year, the IRS maximum carryover is $680 (IRS Revenue Procedure 2025-32).
• Your plan can set a lower carryover amount.
• The carryover doesn't reduce how much you're allowed to elect for the new year, per Publication 969.

Some plans offer neither option. Check your plan documents to see which rule you have.

Made-up example: Ben has $800 left in his health FSA at the end of the 2026 plan year. His plan allows the maximum $680 carryover. He can use $680 next year, and he loses the other $120. If his plan had a grace period instead, he'd have up to 2½ extra months (until mid-March, for a calendar-year plan) to spend the whole $800 on new medical costs.

What can I spend it on?

Qualified medical expenses are the ones your plan allows that would generally qualify for the medical and dental tax deduction. IRS Publication 969 says this includes over-the-counter medicines (with or without a prescription) and menstrual care products.

You can't use a health FSA for:

• Health insurance premiums
• Long-term care
• Costs already covered by another health plan

You'll usually need proof, like a receipt or an explanation of benefits. Many employers give you an FSA debit card, which can make this easier.

Dependent care FSA (different account)

Some employers also offer a dependent care FSA for things like child care. This is a separate account with its own rules. For 2026, IRS Publication 15-B says the dependent care limit was raised from $5,000 to $7,500 ($3,750 if married filing separately).

Tips for not losing money

1. Estimate low, not high. Base your amount on costs you're pretty sure about: regular prescriptions, planned dental work, glasses, or contacts.
2. Know your deadline. Find out whether your plan has a grace period, a carryover, or neither, and when you must submit claims.
3. Set a reminder a few months before the plan year ends to check your balance.
4. Watch out if you want an HSA. A general-purpose health FSA usually blocks you from contributing to an HSA. (See HSA vs FSA.)