What Are the Rules for an FSA Refund?

A Flexible Spending Account, or FSA, is an employer-sponsored benefit that allows you to set aside money for healthcare costs on a pre-tax basis. This reduces your taxable income, as contributions are deducted from your paycheck before federal, Social Security, and Medicare taxes are calculated. The funds can then be used throughout your plan year to pay for qualified medical, dental, and vision expenses that are not covered by your insurance, including costs like deductibles, copayments, and prescription medications.

The Use-It-or-Lose-It Rule

The primary regulation governing FSAs is the Internal Revenue Service (IRS) “use-it-or-lose-it” rule. This principle dictates that any money remaining in your account at the end of the plan year is forfeited. This forfeiture is the main reason you cannot receive a direct cash refund for unused FSA funds, as the IRS considers a refund a form of “deferred compensation,” which is prohibited under Internal Revenue Code Section 125.

When you forfeit funds, they revert to your employer. According to Treasury Proposed Regulation 1.125-5, the employer can use the forfeited amounts to pay for the administrative expenses of the FSA plan. Alternatively, the employer may apply these funds to reduce employee contributions for the following plan year.

This structure encourages careful planning during your annual benefits enrollment. You must estimate your anticipated out-of-pocket medical expenses for the upcoming year to decide how much to contribute. Over-contributing carries the risk of losing that money, while under-contributing means you miss out on potential tax savings for expenses you end up incurring.

Employer-Offered Exceptions to Forfeiture

To soften the impact of the use-it-or-lose-it rule, the IRS permits employers to offer one of two exceptions, but not both. Your employer is not required to offer either of these options, so you must check your specific plan documents to understand what is available.

One available option is a grace period, which provides an additional two and a half months after your plan year ends to incur new eligible expenses. For example, if your plan year ends on December 31, a grace period would allow you to use remaining funds for expenses incurred up until March 15 of the new year. This gives you extra time to use your balance without forfeiture.

The other option is a carryover, allowing you to move a portion of your unused FSA funds to the next plan year. The IRS sets an annual, inflation-adjusted maximum for this carryover; for 2025, this amount is up to $660. Any funds exceeding this limit are forfeited. For instance, if you had $800 remaining, you could carry over $660 and would forfeit the remaining $140.

Impact of Employment Termination

When your employment ends, the rules for accessing your FSA funds change. In most situations, you can only submit claims for eligible expenses incurred before your termination date. You cannot use the remaining balance for medical services received after you have left the company.

Your employer must provide a “run-out period” after your termination date to submit these claims, which is often 30 to 90 days. You must submit all receipts for pre-termination expenses before this deadline passes, or you will lose access to the funds.

You may have the option to continue FSA coverage through the Consolidated Omnibus Budget Reconciliation Act (COBRA). If you elect COBRA, you can use remaining funds for expenses incurred after your termination date. However, you must pay the full monthly FSA contribution out-of-pocket, plus a potential administrative fee of up to 2%. This is often only practical for those who anticipate significant medical expenses shortly after leaving their job.

Limited Scenarios for Direct Refunds

While direct cash refunds from an FSA are uncommon, a few specific situations allow for one. These are not standard procedures but are corrective actions for distinct errors.

One scenario involves an administrative or payroll error. If your employer mistakenly deducted more from your paychecks than the amount you elected to contribute, you are entitled to a refund of the excess contributions. This refund would be processed as taxable income.

Another instance is if your contributions exceed the annual IRS limit. Any contributions made above this legal limit must be returned to you as taxable income. These situations are typically identified and corrected by your employer’s payroll or benefits department.