A Flexible Spending Account (FSA) lets you set aside pre-tax money from your paycheck for eligible healthcare or dependent care costs. It sounds similar to an HSA, but the two work on fundamentally different terms — an FSA is tied to your current employer, doesn't require a specific health plan to qualify, and, unlike an HSA, comes with a real risk of losing unspent money at year-end.

How Contributions Work

FSA contributions come out of your paycheck before taxes, reducing your taxable income the same way a 401(k) contribution does. Unlike an HSA, there's no requirement to be enrolled in a high-deductible health plan — FSAs are generally available to anyone whose employer offers one, regardless of what health plan they're on.

One structural quirk worth knowing: under the uniform coverage rule, your full elected annual amount is available to spend starting Day 1 of the plan year, even if you haven't actually contributed that much yet through payroll deductions. If you elect $3,400 for the year and have a $2,000 medical expense in January, the FSA can reimburse the full amount immediately — your employer is taking on the risk that you'll keep contributing through the rest of the year (or, in most cases, absorbing the loss if you leave the job before finishing your contributions).

2026 Contribution Limits

Per IRS Revenue Procedure 2025-32:

Health FSA limit: $3,400 per employee (up from $3,300 in 2025)

This limit applies per employee, not per household — if you and your spouse each have access to an FSA through separate employers, you can each contribute up to $3,400, for a combined household total of $6,800.

Contribute more than your plan's limit, and the excess loses its pre-tax treatment entirely — it gets taxed as regular wages, eliminating the benefit of using an FSA for that portion in the first place.

The Use-It-or-Lose-It Rule

Here's the defining risk of an FSA, and the biggest structural difference from an HSA: by default, any money left in a health FSA at the end of the plan year is forfeited — permanently gone, regardless of how much you contributed.

The IRS allows employers to soften this with one of two specific relief options — never both, per IRS Notice 2013-71:

A carryover, letting you roll a limited dollar amount of unused funds into the next plan year.

A grace period, giving you an extra 2 months and 15 days after the plan year ends to incur new expenses against last year's leftover balance.

An employer can offer either option, offer neither (leaving straight use-it-or-lose-it in place), but never both together.

The $680 Carryover: Where That Number Actually Comes From

The 2026 carryover limit is $680 — and this isn't an arbitrary IRS-picked figure. Per IRS Notice 2020-33, the carryover ceiling is formally defined as 20% of that year's maximum health FSA salary reduction limit. For 2026:

$3,400 × 20% = $680

This is a detail most FSA explainers skip entirely, but it matters practically: the carryover cap moves automatically whenever the underlying contribution limit changes, rather than being a fixed number the IRS updates on its own separate schedule.

Carried-over funds don't count against your next year's contribution limit either — they're on top of it. Elect the full $3,400 for a new plan year and carry over the maximum $680, and you'd have $4,080 available on Day 1 of the new plan year.

Two Worked Examples

Employee A elects $2,400 for the year and spends $1,850, leaving $550 unused.

Since $550 is under the $680 cap, the full $550 carries over — nothing forfeited.

Employee B elects the full $3,400 and spends only $2,000, leaving $1,400 unused.

Only $680 of that carries over (the maximum allowed). The remaining $720 is forfeited entirely, regardless of how legitimate the original planning was.

That gap between the two outcomes is exactly why FSA elections deserve deliberate estimation rather than defaulting to the maximum contribution "just in case" — overestimating annual medical spending is the single most common way FSA money gets forfeited.

Dependent Care FSA: A Separate Account With Separate Rules

A Dependent Care FSA (DCFSA) — sometimes called a Dependent Care Assistance Program — is a distinct account from a health FSA, governed by different IRS rules, used for eligible child or adult dependent care costs that allow you (and a spouse, if married) to work.

2026 DCFSA limit: $7,500 for single filers and married couples filing jointly, or $3,750 for married filing separately.

This is a significant, genuinely newsworthy change: the DCFSA limit had been stuck at $5,000 since 1986 — nearly four decades with no adjustment, aside from a single temporary pandemic-era increase that later reverted. The One Big Beautiful Bill Act raised it permanently to $7,500 starting with the 2026 plan year, the first real increase in the program's history.

Critically, the standard carryover option does not apply to Dependent Care FSAs the way it does to health FSAs — a DCFSA generally remains subject to straight use-it-or-lose-it treatment (or the grace-period option, if the employer offers that instead), making annual estimation even more important for this account type.

What the Increase Is Actually Worth

At a 22% federal income tax bracket plus the standard 7.65% FICA payroll tax — a combined 29.65% — sheltering the additional $2,500 now available ($7,500 versus the old $5,000 cap) saves roughly $741/year in taxes for a family maxing out the new limit, purely from the OBBBA increase itself.

FSA vs. HSA: The Core Differences

The Limited-Purpose FSA: A Way to Have Both

Enrolling in a general-purpose health FSA is typically disqualifying coverage that would make you ineligible to contribute to an HSA in the same year. Some employers offer a Limited-Purpose FSA instead — restricted specifically to dental and vision expenses — which is structured to be compatible with HSA eligibility, letting an employee use both account types in the same year as long as the FSA is limited-purpose rather than general.

Frequently Asked Questions

What happens to my FSA if I leave my job mid-year?

Generally, your FSA participation ends, and any unused balance beyond what a grace period or COBRA continuation might cover is forfeited — this is a real, practical downside compared to an HSA, which stays with you regardless of employment changes.

Can I change my FSA election mid-year?

Only in limited circumstances defined by the IRS as qualifying life events — marriage, birth of a child, a change in employment status, and similar triggers — not simply because you've realized you elected too much or too little.

Does unused carryover count against next year's limit?

No. Carryover funds are explicitly excluded from counting against the following year's contribution limit, so they add to, rather than reduce, what you can newly elect.

Can I use a Dependent Care FSA and claim the Child and Dependent Care Tax Credit for the same expenses?

Generally not for the same dollars — using DCFSA funds for a specific expense excludes that same expense from also being claimed for the tax credit, so the two benefits don't stack on identical costs, though the better overall choice between the two depends on your specific income and expense levels.

Is FSA money taxed when I use it for eligible expenses?

No. Like the contribution itself, qualified withdrawals from an FSA are entirely tax-free — the tax benefit applies at both ends, as long as the expense qualifies under IRS rules.

Key Takeaways

An FSA offers real, immediate tax savings on healthcare or dependent care costs, funded pre-tax from your paycheck, with the full elected amount for health FSAs available from Day 1 under the uniform coverage rule. Its defining risk is the use-it-or-lose-it structure: only a $680 carryover (a fixed 20% of the $3,400 2026 limit) or a 2.5-month grace period — never both — soften what would otherwise be full forfeiture of unused funds.

The Dependent Care FSA's jump to $7,500 for 2026 is a genuinely significant, decades-overdue change worth knowing about if you have child or dependent care expenses, but it's a separate account from the health FSA with its own rules, including the general absence of a carryover option — making accurate annual estimation the single most important habit for anyone using either account type.

Sources

• Internal Revenue Service — Revenue Procedure 2025-32

• Internal Revenue Service — Notice 2013-71, Modification of "Use-or-Lose" Rule for Health Flexible Spending Arrangements

• Internal Revenue Service — Notice 2020-33, Increase in Permitted Health Flexible Spending Carryover Amount

This article is for general educational purposes only and does not constitute financial, investment, tax, or legal advice.