How to Use Health FSA Forfeitures

Offering a Flexible Spending Account (FSA) is a great way for employers to retain and attract new talent and promote financial wellness. 

Employers may be reluctant to offer an FSA because of the concern that they will end up losing money, due to the universal availability requirement attached to health FSAs. Universal availability allows participants to be reimbursed for expenses up to their full annual contribution election, regardless of how much they have actually deferred into the plan. When employees access the funds early in a plan year, the expectation is that they will pay the amount back before the year is over. However, if an employee terminates prior to the plan year end, the employer ends up paying for those expenses (frequently referred to as an overspent account). 

The good news is that employers can balance the losses from overspent FSA accounts with amounts left behind by other employees who never submit claims for reimbursement. These amounts are referred to as forfeitures. 

Recent research by the Employee Benefits Research Institute (EBRI) indicates that employers should not generally be concerned about overspent accounts. Early studies reveal that participants are regularly forfeiting substantial FSA sums. Results from a study conducted in 2020 reflected that 40% of FSA owners forfeited at least some of their FSA dollars. Average per-participant forfeitures were between $339-$408.

With all these funds being left behind by participants, instead of overspent accounts employers may instead face the problem of over-funded FSAs. What should an employer do with these forfeitures?

FSAs are subject to both the Internal Revenue Code and ERISA (unless the employer is exempt from ERISA because they are a governmental or church entity). Within these laws there are restrictions that govern how employers can use forfeited dollars. For health FSAs, employers are permitted to use forfeitures in the following ways:

• to reduce salary reductions for the following year on a reasonable and uniform basis,
• to return to employees on a reasonable and uniform basis, or
• to defray plan expenses.

The most common way employers use forfeitures is to defray plan expenses, using the forfeiture to pay the administrative expenses of their FSA third-party administrator (TPA). If the TPA administers multiple plans for the employer, the forfeitures should not be used to pay any other plan’s expenses. 

The forfeitures can also be used against salary reductions in the following year or returned to employees. However, both methods require the employer to allocate the forfeitures on a “reasonable and uniform basis,” meaning that the amounts cannot be directed at the employees who actually forfeited their balances, but spread across all participants in the plan. 

ERISA prohibits employers from retaining excess funds, but for plans not subject to ERISA (e.g. dependent care FSAs, or health FSAs offered by ERISA-exempt employers) this is an option. 

The FSA plan document may provide further guidance or direction on the use of forfeitures, and in that case the employer should also follow the requirements of their plan document.   

Employers who have substantial FSA forfeitures in their plan may want to focus on employee education to reduce amounts employees leave behind and ensure that they are able to make the most of their benefits. Employers can also provide a grace period or a carryover to permit participants additional time to use their FSA dollars. Another solution is to offer a runout period of 90 days to submit claims, allowing employees the longest possible periods of time to submit claims and reduce FSA funds left behind at the end of the year.