What is a Flexible Spending Account?

A Flexible Spending Account (FSA) is either a Health Spending Account (HSA) or a Personal Spending Account (PSA). This employer-provided benefit allows employees to allocate money toward eligible health and wellness expenses. These accounts give employees more control over their benefits spending by allowing them to use pre-tax dollars to cover health-related costs, fitness programs, or personal expenses, depending on the account type. FSAs are popular in Canada as part of a group benefits package.

What kind of expenses are typically covered by an HSA?

The Canada Revenue Agency (CRA) determines the various medical and dental expenses covered by FSAs through HSAs. However, employers decide what is eligible under a PSA. HSAs typically cover the following:

Medical expenses

Health-related costs such as prescription medications and paramedical services like physiotherapy or chiropractic care are generally covered as long as the CRA considers these as essential services. HSAs can also help pay for doctor visits, diagnostic tests, and necessary surgeries.

Dental and orthodontic expenses

Individuals can also request reimbursement for dental treatments, such as cleanings, fillings, crowns, and braces. Orthodontic treatments, which can require a substantial investment, may also be covered.

Vision care

An HSA can reimburse routine eye exams, prescription glasses, contact lenses, and corrective procedures like LASIK surgery, helping employees with out-of-pocket costs for maintaining good vision health.

Dependent care expenses

Dependent care expenses are another primary feature of HSAs, especially for employees with children or elderly family members. Eligible expenses might include daycare, care for older adults, and after-school programs that allow employees to work while their dependents are cared for.

What does a PSA cover?

Employers have unlimited flexibility with PSAs and can be more creative with what they offer. On top of the above benefits, here are some examples of additional PSA expenses that may be eligible:

• Fitness-related costs, such as gym memberships or equipment
• Education fees, tuition, and books to support employees’ continued learning
• Personal or professional development, including online courses and workshops
• Childcare expenses like daycare or summer camps
• Alternative transportation options, such as bus passes or bicycles
• Green initiatives, like energy-efficient appliances or solar products
• Smoking cessation programs to promote healthier lifestyles
• Adult care, including companionship services or community activities
• Equipment like air conditioners, heaters, or fans for remote workers to stay comfortable

Limitations of a Flexible Spending Account

While HSAs help cover eligible healthcare or dependent care expenses, they have some limitations:

Eligible expenses only

HSAs cover only qualified medical and dependent care expenses. Ineligible expenses, such as elective cosmetic surgeries or non-prescription medications, may not be reimbursed unless they are part of a PSA. When employees know which expenses their plan approves, it can help maximize their benefits.

Potential for confusion

The detailed rules around what qualifies as an eligible expense and how FSAs interact with other benefits can be confusing. Misunderstanding these guidelines could result in denied claims or unexpected out-of-pocket costs.

Use it or lose it rule

Employees must use the funds within the calendar year or forfeit any remaining balance. Some employers offer a grace period, but tight timelines can stress out employees who can’t predict their healthcare needs over a year.

Lack of portability

With FSAs linked to employment, employees who leave their jobs can’t take their FSA with them.

How do Flexible Spending Accounts work?

An FSA allows employees to choose a set pay cheque deduction before taxes, which then goes into their FSA. This pre-tax contribution reduces taxable income and offers immediate savings on annual taxes. Below is a breakdown of how FSAs work:

• Employee sign-up: During open enrollment, employees decide how much to allocate to their FSA for the year.
• Payroll deductions: The employer deducts the elected amount from the employee’s pay cheque in equal instalments throughout the year.
• Using FSA funds: Employees can use their funds to pay for eligible expenses either through reimbursement or a direct FSA debit card if provided.
• Claims submission: Employees typically submit receipts or documentation to claim reimbursement for eligible expenses.
• Year-end settlement: At the end of the year, employees either use their allocated funds or risk losing the balance.

How do I set up an FSA for my employees?

Setting up an FSA can involve several steps, as outlined below:

1. Choose a benefits provider

Employers partner with a benefits provider or insurance company that offers FSAs. These providers can manage the administration, claims processing, and compliance with applicable tax laws.

2. Establish plan guidelines

Employers typically set transparent rules for the program, including the maximum contribution limits and eligible expenses and if they offer a grace period for leftover funds.

3. Engage with employees and offer training

Regular communication can help ensure employees understand the value of their FSA. Explain how an FSA works, the expenses covered, how it benefits employees, and the deadlines for using the funds.

4. Integrate with payroll

Employers can integrate their FSA program with their payroll system for seamless pre-tax deductions.

Pros of offering FSAs to employees

There are several advantages to offering an FSA program to employees, such as:

• Tax savings: Employers and employees benefit from tax savings. Employers can save on payroll taxes, while employees reduce their taxable income.
• Higher employee satisfaction: Offering an FSA shows a commitment to employee wellbeing by helping them manage out-of-pocket health and dependent care expenses.
• Enhanced recruitment and retention: Competitive benefits, such as PSAs or HSAs, can help attract new applicants and improve employee retention.
• Customizable benefits: You can tailor FSAs to cover a range of health-related or dependent care expenses, offering employees personalized financial support.

Potential cons of offering FSAs to employees

There are also some challenges when offering FSAs to employees, as noted below: 

• Complexity: Setting up and managing FSAs can be challenging for administrators, especially for smaller businesses without a dedicated HR team.
• Costs for employers: While employers benefit from tax savings, they’re also responsible for the costs of administering the FSA program, which may include fees to third-party administrators.
• Limited flexibility: FSAs are restrictive regarding eligible expenses and their use it or lose it policy, which may discourage some employees from participating fully.
• Low participation rates: Not all employees may find the FSA program useful, which could mean lower participation rates, reducing its benefits for both employees and employers.

Flexible Spending Account FAQs

The following are answers to some frequently asked questions about FSAs:

What is the difference between an HSA and a PSA?

According to Canada Revenue Agency (CRA) guidelines, a Health Spending Account (HSA) is a tax-free benefit that covers eligible healthcare expenses, such as prescription drugs and dental care. In contrast, a Personal Spending Account (PSA) offers more flexibility, allowing employees to claim more types of expenses, including wellness and lifestyle-related items, though these funds are taxable as income.

Can an employee carry FSAs over to the next year?

Some FSAs allow for the carry-over of unused funds, but this often depends on the employer’s plan and other provincial or territorial regulations. For example, in Alberta, employees can carry unused funds to the next plan year. The oldest funds are used first (first in, first out). However, employees forfeit anything from the previous year that remains unused by the end of the run-off period in the following year (two months after the plan end date). Employees cannot carry forward funds for more than one year.

Are FSAs taxable?

HSAs provide tax-free reimbursements for medical and dental expenses, but the CRA considers PSAs as part of an employee’s total compensation package, making them taxable employee benefits.

Can I offer my employees both an HSA and a PSA?

Yes, many employers offer a combination of HSAs and PSAs, giving employees more flexibility in how they spend their benefits. A Health Spending Account works similarly to a Personal Spending Account, but it provides different types of coverage. The employer allocates an amount of money for employees in both setups. Despite similarities in structure, the differences in coverage and regulations make them distinct.