Understanding the Benefits of Flexible Spending Accounts (FSA) for Public Sector Employees

Despite their significant tax-saving advantages, Flexible Spending Accounts (FSAs), by many accounts, are one of the most underutilized, misunderstood, and often overlooked employee benefits available to public sector employees. Employees across the country forfeit millions of dollars annually, emphasizing the urgency for employees to better understand how and when to use their FSA dollars.

If your team is new to FSAs or still getting comfortable with how they work, this guide covers the basics, the benefits, as well as a few key points to keep in mind when communicating this benefit to employees.

What Is a Flexible Spending Account (FSA)?

An FSA is an employer-sponsored benefit designed to help employees manage eligible expenses tied to healthcare and dependent care needs. Flexible spending accounts allow employees to set aside pre-tax dollars for healthcare (Healthcare FSA) and/or dependent care (Dependent Care FSA) costs. These costs can include doctor visits, prescriptions, medical supplies, dental work, vision care, daycare, and more. 

When employees contribute to an FSA, those dollars are excluded from their taxable income before federal, state, and most local income taxes are calculated. By setting aside pre-tax dollars, an employee’s taxable income is lowered – making these everyday expenses easier to pay for and manage. The use of these accounts can save participants an average of 30% on eligible costs by leveraging pre-tax savings.  

There are two distinct types of FSAs – Healthcare FSA and the Dependent Care FSA – that each have rules and regulations. Healthcare FSA funds can be used for copayments, deductibles, dental and vision care, and prescriptions. Health insurance premiums are ineligible. Dependent Care FSA funds can cover daycare for children under age 13, preschool tuition, after-school care, and elder care expenses for dependent adults. However, there’s a critical qualification: the dependent care must be work-related, meaning it must allow the employee (and spouse, if married) to be gainfully employed. A spouse caring for a dependent full-time does not meet the gainful employment requirement, and therefore, dependent care expenses would not qualify.

Not sure what counts as an eligible expense? The IRS provides a helpful list for you to reference.   

FSA Contribution Limits and Planning Ahead

FSA contribution limits and carryover rules are set by the IRS and can change each year. For current contribution limit information, the IRS posts updates here. For 2026, the maximum contribution limit for a Healthcare FSA increased to $3,400, up from $3,300 in 2025. For a Dependent Care FSA, the maximum increased to $7,500, up 50% from $5,000 in 2025. Reviewing these limits with employees helps them decide how much to set aside for the upcoming plan year based on their household needs. 

At the beginning of their plan year, employees elect a total amount they plan to use for eligible expenses in that year, and their employer contributes that total amount to the employee’s FSA. The total amount elected by the employee is repaid to their employer in equal installments throughout each paycheck.  FSA participation must be re-elected every year; it does not automatically continue.

Navigating the FSA Deadline Year-End and the “Use or Lose” Rule

While FSA plans follow a use-or-lose rule, meaning any unused funds at the end of the plan year are forfeited back to the employer, the majority of employers offer employees flexibility in one of two ways:

• A small rollover allowance: This option allows employees to carry over a set maximum amount of unused funds into the next year. The IRS permits up to $660 to be carried over from 2025 into 2026.  
• A short grace period after the plan year ends: This gives employees up to two and a half (2.5) extra months to spend their prior year’s funds on eligible expenses.   

Each employer sets these rules. It’s always recommended that HR teams communicate their specific deadlines and FSA carryover rules with employees throughout the year and especially during Open Enrollment. Clear and frequent reminders can go a long way and make the benefit that much more valuable to employees.

How to Make the Most of FSA Funds 

Employees often appreciate information and reminders of eligible expenses, how and when to check their balance. A few simple steps can help employees make the most of their FSA dollars and protect their pre-tax savings:

• Review Current Balance: Taking a look at your current balance frequently to avoid a last-minute scramble. Employees who have a high balance may need to plan for larger purchases, while others may only need a few routine items.   
• Look at Upcoming Appointments: Eye exams, dental cleanings, and check-ups are common visits in the new year. If an employee or dependent has been planning to schedule something like orthodontics, this may be a good time to use FSA funds since FSA funds cover medical, dental, and vision expenses.   
• Restock Household Medical Items: Eligible items can include bandages, contact lens supplies, thermometers, sunscreen (SPF 15+), pain relievers, and more. Many people already use these products, so this step feels practical and easy. A helpful guide to eligible items can be found here.

It is also a good idea to remind employees about the Run-Out Period. This is the extra time given after the plan year or grace period ends for submitting receipts for expenses already incurred during the previous plan year.  

Supporting Employees Through FSA Decisions

Support employees through their FSA decision-making process with clear communication and simple reminders. This combination often makes the biggest difference. Short email check-ins, text reminders, a quick resource sheet, or a short video shared internally can help employees understand their options and deadlines without feeling overwhelmed.   

If your organization needs support in developing benefit education resources that improve how information reaches your employees throughout the year, VSMG is here to help create a strategy that fits your workplace. Learn more about our approach to employee benefits here.

About VSMG

Built by and for Arizona public sector employers, VSMG is a leading employee benefits consultant, dedicated exclusively to serving the needs of Arizona’s school districts, municipalities, and other public entities for over 20 years. We are the largest provider of employee benefits consulting services to Arizona school districts, serving over 40,000 benefit-eligible employee lives, and the only nonprofit consultant offering these services.