Options For Employers Handling Leftover FSA Funds - Chard Snyder

Options for Employers Handling Leftover FSA Funds

February 27, 2020

For employees, the main downside to a Flexible Spending Account (FSA) can be the “use-it-or-lose-it” rule. If an employee doesn’t incur enough qualified expenses to use all FSA funds, any leftover balance generally reverts back to the employer after the end of the year.

(Employers can provide two exceptions to the “use-it-or-lose-it” rule: Offering a grace period for employees to use up the remainder of their previous health FSA balance or providing a $500 carryover of unused balances from one year to the next.)

When unused FSA balances are forfeited back to the employer, several options exist for what can be done with the money. However, there are a number of rules that dictate exactly how funds can be used.

As an initial matter the employer should review the plan document, which may directly state how forfeitures should be handled and what steps must be taken. Employers using a third-party administrator (TPA) should also make sure the option chosen can be handled by their TPA.

The first step is then to use leftover FSA funds to offset amounts paid to employees who spent more than their contributions during the year. Employers should wait until the end of any run-out period as employees may have incurred expenses, but not yet submitted them for reimbursement. Most plans have a set period (e.g., March 31 of the following year, for a calendar year plan) to submit expenses for the prior year.

If any money is left over after that period, the employer has four options and can use one or more of them until all leftover health FSA funds are spent:

1. Reduce Administrative Expenses

Employers can use forfeited funds to pay their health FSA administrator (e.g., plan TPA). Employers should first determine if their plan is subject to ERISA (the majority of health FSAs are). This federal law requires that leftover funds must be used for the benefit of participants specifically in the health FSA plan. Using leftover funds to benefit another plan or its participants could lead to excise taxes and civil monetary penalties. Taking the money back into corporate assets is also a prohibited transaction under ERISA which can lead to fines and penalties.

If leftover funds are used to pay FSA administration expenses, the employer will need detailed records showing exactly how the payments relate to the FSA, as well as documentation on the nature and amount of the expenses, and the date they were incurred and paid.

This is by far the cost popular approach because it (indirectly) lowers the employer’s cost to administer the plan. It also does not require any communication to employees, beyond the standard summary plan description.

2. Reduce Employee Salary Contributions

The leftover money from a year can be used to reduce employees’ FSA contributions in the following year. This must be done on a reasonable and uniform basis, and comes with a few requirements:

• The money can be allocated per person (e.g. $50 per person) or weighted based on plan elections (e.g., employee who elected $500 gets $10, employee who elected $1,000 gets $20).
• The money cannot be allocated based on reimbursements made. Employers cannot return money based on how employees have spent/are spending their health FSA funds.

Can leftover funds from 2019 be used for all participating employees in 2020 or only those who were in the health FSA in 2019? The more conservative approach is to allocate it only to those who participated the previous year.

Employees tend to like this option since it increases their take-home pay. However, good communication to employees is key. If the employer takes the more conservative approach, some employees who didn’t participate in the prior year may feel unfairly treated.

3. Increase Reimbursements

Employers can increase the maximum reimbursement for employees, so all employees get an extra amount above what they elected for the next year. As with the previous option, the increase can be provided per person or per elected amount, but not in proportion to reimbursements made.

The same question exists about whether all employees in the plan can receive the increase or only those who participated in the previous year. Also, many employees made the current year’s elections without assuming these increases and may not be able to use the funds. If so, then these will just become leftover funds for the next year. This option would also require clear employee communication, and may be difficult for the plan TPA to administer.

4. Cash Refunds

As a final option, employers can issue cash refunds. Again, the refunds can be per person or in proportion to elections, but cannot be in proportion to expenses reimbursed. Additionally, there is a stronger argument that those who contributed to the leftovers should receive the refund, which may involve chasing down former employees who participated in the health FSA. These cash refunds are taxable, so withholding taxes would apply.