Health FSAs: 5 things employers may not know
By William G. (Bill) Stuart
Employees who participate in a company’s Health FSA plan defer a portion of their income into a tax-free account to pay for qualified medical, dental, and vision expenses, as well as over-the-counter drugs, medicine, equipment, and supplies. They make an election in advance of the plan year and can change that election only with a status change (like birth, adoption, marriage, divorce, or death). You divide each participant’s election by the number of payroll periods in the plan year and deduct that amount from each paycheck.
A Health FSA is a notional account, which means employers don’t fund each employee’s account in full at the beginning of the plan year. Instead, a third-party administrator requests a small working balance from which to settle debit-card purchases and pay claims. The company then replenishes the fund regularly to bring the account back to the working balance.
COBRA continuation generally doesn’t apply to Health FSAs, although employees whose payroll deductions exceed their spending when their coverage is terminated may be permitted to continue their plan to spend the amount of their cumulative payroll deposits.
Here are five things employers may not know about Health FSAs:
1. Employers can choose a lower limit than max
The Internal Revenue Service (IRS) sets the annual maximum election, which is adjusted for inflation. The limit for plans that start in 2022 is $2,850. You can choose a lower limit if you wish.
The election limit is a balancing act. Most employers want to support employees with high out-of-pocket expenses by allowing them to elect as much as they need to pay those expenses with pre-tax funds. And you benefit from higher elections because the company doesn’t pay federal payroll taxes (7.65% on incomes below $147,000 in 2022) on employees’ elections.
A mandatory Health FSA feature is uniform coverage. Which means, participating employees have access to their full election on the first day of the plan year – even though they pay level payroll deductions each pay period. If an employee ceases participation – for example, by leaving the company or losing eligibility by moving from full- to part-time employment – employers can’t recoup any excess of spending over funding for the year. Employers accept uniform coverage as part of the risk of offering the plan, just as employees accept the risk of forfeiting unused balances as part of their participation in the plan.
There is no minimum election in the tax code. Employers can also set a minimum election to enjoy enough payroll-tax savings to offset at least a meaningful portion of the annual account fee charged by the administrator.
2. Employers can contribute to employees’ Health FSAs
Employers are permitted under federal tax law to contribute to employees’ Health FSAs, though few do. Employees – even those who are healthy – may incur eligible expenses for contact lenses and solution, an occasional dental cavity, routine cost-sharing on the medical plan, or over-the-counter drugs and medicine to self-treat simple injuries, illnesses, and conditions.
Offering even a small employer contribution – such as $100 to $200 – may help employees receive and appreciate the benefits of the Health FSA, even if they don’t add any money of their own (though you could require an employee match to collect your contribution). The employer contribution doesn’t count against their election limit.
3. Employers can limit the risk of forfeiture
Most employers don’t want their employees to forfeit balances, even though the company retains those funds. The risk of forfeitures tends to reduce enrollment, and actual forfeitures prompt further reductions in future enrollment among employees who lose balances and co-workers who hear their stories.
Employers can add one of two (but not both) options to allow employees more time to spend their balances:
- Carryover. Permit employees to carry over a portion of their unspent balances at the end of the year. The amount is limited to no more than 20% of the statutory maximum election. For Health FSA plans starting 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.
- Grace period. Employers can add an additional two months and 15 days to the plan year to allow participants additional time to spend that Health FSA plan year’s balances. This option gives employees 14½ months to spend their elections. They can monitor their spending and adjust the following year’s election to reflect the unused balance they can spend early during the next plan year.
Another benefit to employees: The grace period provides overlapping plan years. A participant with an expense greater than a single year’s election limit – like vision-correction surgery or orthodontia treatment – can schedule these services during the overlap period and spend both the prior year’s balance during the grace period and the new plan year’s balance on these higher-cost services.
Employers aren’t required to offer either option, but the risk is minimal since payroll deductions for balances available during the grace period and 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.
4. Employers determine the plan year
Though the majority of 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, a best practice is to align the Health FSA plan year with the medical plan year. That way, employees can react to changes in cost-sharing on the medical plan as they set their Health FSA election for the following year. Otherwise, a sudden change in projected expenses isn’t a qualifying event to adjust an election up or down during the Health FSA plan year.
With some business calendars, it may be beneficial to align the medical and Health FSA plan years. For other organizations, might choose to adopt a different model. For example, a school district with a fixed July 1 renewal date for the medical plan could consider holding the open-enrollment period for the medical plan and Health FSA simultaneously in mid-May, but not start the Health FSA until September, when the school year typically begins.
Employers can run a shorter (less than 12-month) plan year to align a new effective date to reflect a legitimate business need (such as in the example above). But a plan year of less than 12 months is an exception and reserved for purposes of a one-time plan year realignment.
5. 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, such as activities around open enrollment like meals and raffles or other benefits, such as tuition reimbursement or other insurance options. (Note: This income stream can vary from year to year, making it a less desirable option to fund ongoing coverage.)
- Return the funds to participants. Employers can’t return forfeited balances in proportion to the forfeiture (e.g., give participants their forfeited amounts back). But the total amount can be forfeited evenly across all participants. For example, if an employer has $2,000 in forfeitures and 50 employees participate the next year, each participant could receive an employer contribution of $40 ($2,000 divided by 50).
The bottom line
Though Health FSAs must meet certain prescriptive requirements under the federal tax code, there is some flexibility to craft a program to meet both the employer’s and employees’ needs. Be sure to understand and apply this flexibility to design the optimal offering.
William G. (Bill) Stuart is Manager, Planning and Business Analysis at Voya Financial. He has nearly three decades’ experience in employee benefits and had worked with Health Savings Accounts since their introduction in 2004. He chairs the American Bankers Association HSA Council’s compliance committee and is the author of HSAs: The Tax-Perfect Retirement Account.
This information is provided by Voya for your education only. Neither Voya nor its representatives offer tax or legal advice. Please consult your tax or legal advisor before making a tax-related investment/insurance decision.
Flexible Spending Accounts offered by Voya Benefits Company, LLC (in New York, doing business as Voya BC, LLC). Administration services provided in part by WEX Health, Inc.
This highlights some of the benefits of a Flexible Spending Account. If there is a discrepancy between this material and the plan documents, the plan documents will govern. Subject to any applicable agreements, Voya and WEX Health, Inc. reserve the right to amend or modify the services at any time.
The amount saved in taxes will vary depending on the amount set aside in the account, annual earnings, whether or not Social Security taxes are paid, the number of exemptions and deductions claimed, tax bracket and state and local tax regulations. Check with a tax advisor for information on whether your participation will affect tax savings. None of the information provided should be considered tax or legal advice.
This information is provided by Voya for your education only. Neither Voya nor its representatives offer tax or legal advice. Please consult your tax or legal advisor before making a tax-related investment/ insurance decision.
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