Flexible Saving Plans, such as Flexible Spending Accounts (FSAs) or Health Savings Accounts (HSAs), offer excellent ways to save money on medical expenses and reduce your taxable income. However, these plans come with rules and restrictions that, if not carefully followed, can result in penalties or the loss of funds. Understanding the nuances of these plans and knowing how to manage them properly can help you avoid costly mistakes and maximize your savings.

In this blog, we’ll dive into the common penalties associated with Flexible Saving Plans and provide practical tips on how to avoid them. By the end of this guide, you’ll be equipped to take full advantage of your flexible savings accounts without the risk of losing money.

What Are Flexible Saving Plans?

Flexible Saving Plans, like FSAs and HSAs, are tax-advantaged accounts that allow you to set aside money for qualified medical expenses. Here’s a brief overview of each:

• Health Savings Accounts (HSAs): These accounts are available to individuals with high-deductible health plans (HDHPs). They allow for tax-free contributions, growth, and withdrawals when used for qualified medical expenses.
• Flexible Spending Accounts (FSAs): FSAs allow employees to contribute pre-tax dollars from their paycheck for medical expenses. FSAs are typically offered by employers as a benefit but come with a use-it-or-lose-it rule.

While both accounts offer great benefits, they also come with specific rules that, if violated, can result in penalties or the loss of funds.

Common Penalties in Flexible Saving Plans

Understanding the penalties associated with Flexible Saving Plans is the first step in avoiding them. Here are some common pitfalls and penalties to watch out for:

1. Use-It-or-Lose-It Rule (FSAs)

One of the biggest drawbacks of FSAs is the use-it-or-lose-it rule. If you don’t use the funds in your FSA by the end of the plan year (or grace period, if offered), you lose the remaining balance.

• Penalty: Any unused funds will be forfeited, meaning you won’t be able to access them for future use.

How to Avoid It:

• Plan ahead and try to estimate your medical expenses for the year.
• If your FSA allows a grace period (usually 2.5 months), make sure to use the funds before it expires.
• If your employer offers a carryover option (up to $610 for 2025), consider saving the balance for the next year.

2. Ineligible Expenses (FSAs & HSAs)

Both HSAs and FSAs allow you to pay for eligible medical expenses tax-free, but using the funds for non-qualified expenses can result in penalties.

• Penalty: For HSAs, withdrawing funds for non-medical expenses before the age of 65 results in a 20% penalty (this is reduced to 10% for individuals over 65). For FSAs, non-qualified expenses result in disqualification of the expense, and the amount is considered taxable income.

How to Avoid It:

• Familiarize yourself with the IRS guidelines regarding eligible medical expenses. Common eligible expenses include prescription medications, doctor visits, dental care, and vision treatments.
• Keep detailed records and receipts of your purchases to avoid mistakes.
• If you’re unsure whether an expense is eligible, check with your account administrator or the IRS website.

3. Exceeding Contribution Limits (HSAs & FSAs)

Each year, both HSAs and FSAs have contribution limits. For FSAs, the contribution limit for 2025 is $3,050. For HSAs, the contribution limits for 2025 are $3,850 for individuals and $7,750 for families. Exceeding these limits can trigger penalties.

• Penalty: Excess contributions may be subject to a 6% penalty, and the excess funds must be withdrawn to avoid additional taxation.

How to Avoid It:

• Stay informed about the contribution limits for each plan. You can adjust your contribution to stay within the allowed limits by checking your payroll deductions.
• If you accidentally contribute too much, withdraw the excess funds before the tax filing deadline to avoid penalties.

4. Failure to Use Funds for Qualified Medical Expenses (HSAs)

While HSAs are more flexible than FSAs (funds roll over year to year), they still have strict rules about how funds can be used. If you use HSA funds for non-medical expenses before the age of 65, you will face penalties and taxes.

• Penalty: If the funds are not used for qualified medical expenses, the withdrawal is subject to both income tax and a 20% penalty if you are under 65.

How to Avoid It:

• Ensure that withdrawals from your HSA are for qualified medical expenses.
• Keep receipts for medical expenses in case of IRS audit.
• If you are over 65, the 20% penalty no longer applies, but the amount will still be taxed as income if used for non-medical purposes.

5. Not Keeping Track of Deadlines (FSAs & HSAs)

Missing deadlines for contributions, claims, or fund usage can result in lost opportunities and penalties.

• Penalty: If you miss the deadlines for submitting claims or if you don’t use your funds before the deadline, the unused funds may be forfeited.

How to Avoid It:

• Set calendar reminders for key dates like FSA plan year-end dates, grace period deadlines, and contribution deadlines.
• Stay organized by keeping track of any medical bills or receipts you’ve submitted for reimbursement.
• Regularly check your account balance to ensure you are on track to use all of your funds.

How to Maximize Your Flexible Saving Plans and Avoid Penalties

To make the most of your HSAs and FSAs, here are some additional tips to help you avoid penalties while maximizing the benefits:

• Plan Your Contributions: Contribute an amount that aligns with your estimated medical expenses. Avoid over-contributing or under-contributing.
• Use a Financial Planner or Tax Professional: For more complicated situations, consider consulting a professional who can help you navigate the rules and avoid costly mistakes.
• Review Your Plan Regularly: Keep up with any changes in your plan and the IRS regulations. Update your contributions and healthcare needs as necessary.
• Utilize Online Tools: Many HSA and FSA administrators offer online tools to track spending and help you stay within the rules.

Conclusion: Stay Informed and Avoid Penalties

Flexible Saving Plans are a powerful tool for managing medical expenses and saving on taxes, but they come with specific rules that must be followed carefully. By staying organized, tracking your contributions, and only using the funds for qualified medical expenses, you can avoid penalties and make the most of your savings. Whether you’re using an FSA or HSA, proactive planning is key to ensuring that these plans work to your advantage.