Is Your Flexible Spending Account Configured to Meet Your Company’s Needs?

Flexible Spending Account (FSA) plans must be designed to meet the requirements defined in federal tax code, but employers have several opportunities to choose features that best fit the needs of their organization.

Employers choose the limit for their Health FSA

The Internal Revenue Service (IRS) sets the annual maximum election, which is adjusted for inflation. For plans that start in 2022, the limit is $2,850. The limit for plans that start in 2023 will not be announced until later in 2022 – perhaps October or early November.  Employers can determine a lower limit, if desired.

What to consider when choosing a limit:

  • Employees with high out-of-pocket expenses will want to elect as much as they can to pay those expenses with pre-tax funds.
  • Employers benefit from higher elections because the company doesn’t pay federal payroll taxes on employees’ elections (7.65% on income amounts below $147,000 in 2022).
  • The Health FSA’s uniform coverage rule states that employees must have access to their full election amount on the first day of the plan year, and even if an employee ceases participation (due to leaving the company, for example), the employer is not permitted to recoup any excess of spending over funding for the year. This means the employer could lose funds when an employee leaves. On the other hand, an employee could lose funds contributed but not spent when they leave the company or have money remaining in their account at the end of the plan year.
  • There is no minimum election amount specified in the tax code. Employers can set a minimum election amount for participation. This allows the employer to ensure that there is enough payroll-tax savings to offset at least a meaningful portion of the annual account fee charged by the administrator.

Employers may contribute to employees’ Health FSAs

Employers are permitted to contribute to their employee’s Health FSAs. While there is no prescribed limit to the amount that an employer can contribute, the contribution must be a one-to-one match or not exceed $500 so as to ensure the Health FSA remains an “excepted benefit”. When the plan is not an “excepted benefit” it is required to provide a Summary of Benefits and Coverage (SBC) and pay Patient-Centered Outcomes Research Institute (PCORI) fees.

Here are some considerations:

  • Even healthy employees would appreciate the benefit of employer funds in a Health FSA. The account can be used for things like glasses, contact lenses, and contact lens solution; occasional dental work; routine cost-sharing on the medical plan; over-the-counter drugs and medicine to self-treat simple injuries, illnesses, and conditions; and menstrual hygiene products.
  • Offering even a small employer contribution may encourage employees to use and value the benefits of the Health FSA.
  • The employer contribution doesn’t count against the employee’s election limit.

Employers can also contribute to an employee’s Dependent Care FSA

Employers may contribute to an employee’s dependent care FSA up to the maximum allowed for the tax year, but the amount the employer contributes decreases the amount that the employee can contribute. The IRS limits the combined employer and employee contributions to $5,000 per year if the employee is married, or $2,500 per year if filing a separate return.

Year-end features can help employees minimize losses

The general rule of an FSA is that any funds left at the end of the plan year and claims filing period are forfeited.  There are, however, a couple of ways a plan can be designed to help employees avoid losses. This may include one, but not both of the following options:

  1. Carryover. The carryover provision allows employees to carry over unspent balances at the end of the plan year (up to a specified maximum carryover amount). The maximum carryover amount is limited to no more than 20% of the IRS maximum election for that year. Therefore, for Health FSA plans that start in 2022, the maximum carryover is $570 (20% of the statutory maximum election of $2,850). Employers can set a lower carryover limit and set restrictions to manage program costs. For example, employees can roll over a balance only if they make an election for the following plan year or if the balance meets a specified minimum amount. This option is only allowed to be used with Health FSAs and Limited Purpose FSAs. Dependent Care FSA plans cannot offer a carryover but can have a grace period.
  2. Grace period.Adding a grace period allows participants an additional two and a half months to spend any balance remaining at the end of the Health FSA’s plan year. (This option is not recommended if the employer also offers a high deductible health plan (HDHP) with a health savings account (HSA) as it makes changing from a traditional plan with an FSA difficult. Employees that have a balance at the end of the health FSA plan year would continue to participate in the Health FSA during the following plan year, making them ineligible to open and contribute to a health savings account until after the grace period has ended.)

Things to consider:

  • The fear of possibly losing money contributed to the plan can discourage employees from enrolling. Having more time or the ability to carry over funds at the end of the year gives new participants confidence to try the plan.
  • Employees should be advised that they can adjust future years contributions so those who experience losses will choose to enroll in future plan years.
  • The risk for an employer to include these provisions is minimal since payroll deductions for balances available during the grace period and funds carried over into the new plan year have already been collected. The only financial risk is incurring monthly account fees with no payroll-tax savings offset if the participants don’t participate during the new plan year.

Employers determine the plan year

Though many Health FSAs run on the calendar year – either to align with the medical plan renewal or to run on the tax year – employers can set any 12-month plan year that makes sense for the business.

In most cases, it is best is to align the Health FSA plan year with the medical plan year. That way, employees can adjust to any changes in cost-sharing on the medical plan as they make their Health FSA election for the following year. Also, this would not cause any conflicts if an employee wished to move to a high deductible health plan with an HSA

Employers can use a short plan year (less than 12-months) to align to a new effective date to reflect a legitimate business need, but a plan year of less than 12 months is an exception and must be reserved for purposes of a one-time plan year realignment.

Employers choose what to do with forfeited balances

When participants don’t spend their entire elections and file claims by the deadline, the unspent balances are forfeited to the plan sponsor. Employers have a few options when deciding what to do with unspent elections:

  • Offset plan expenses.Employers can use the forfeited funds to offset their plan expenses. Most administrators charge an annual fee and a monthly account fee to administer a Health FSA – payroll-tax savings offset much of this expense. A $1,000 election reduces payroll taxes paid by $76.50 in most cases, which is typically enough to offset the monthly account fee for that participant. 
  • Offset other employee-benefits expenses.Employers can direct forfeitures to fund other employee benefits. These funds could be used for activities that are part of open enrollment like meals and raffles, or other benefits, such as health or dental insurance.
  • Return the funds to participants.Employers can’t return forfeited balances to the participants, but they can distribute the total amount forfeited evenly across all participants. For example, if an employer has $3,000 in forfeitures and 75 employees participate the next year, each participant could receive an employer contribution of $40 ($3,000 divided by 75).