Design Health Care FSAs to Be Cost-Effective

Techniques to Increase FSA Participation

• Maintain frequent and effective communications which show employees the value of participation.
• Make it easy for employees to enroll or obtain information about the plan.
• Facilitate claim filing for employees. This can include the use of stored-value, debit-type cards that employees can use to make FSA-related purchases or payments.

Two Ways the IRS Added More Flexibility to FSAs

1. In a welcome move for employers and employees, the IRS relaxed the rules for FSAs several years ago.  Employees may be able to get an extra 2 1/2 months after year-end to spend the money set aside in their accounts before they lose it. (IRS Notice 2005-42)

This grace period is not automatic. In order to take advantage of the grace period, however, employers must amend FSA plans by December 31 to permit the extra 2 1/2 months — through March 15 of the following year (this assumes the FSA plan operates on a calendar-year basis, which is almost always the case). Employees can use any unspent year-end balances to reimburse themselves for qualified expenses incurred within the grace period.

2. Beginning in 2013, a second provision was added, as an alternative to the 2 1/2 month grace period rule. Employers can now amend health care FSA plans to allow participants to carry over up to $500 of any unused balance from the current year to the following year. (Health care FSA plans can offer either the grace period rule or the $500 carryover privilege, but not both.) The $500 carryover privilege is only allowed for health care FSAs (not dependent-care FSAs).

Essential to understand: The use-it-or-lose-it rule still exists, but the grace period and the $500 carryover rules allow employees more time to use FSA balances.

Health care FSAs offer employers strategic advantages, too. With rising medical costs, implementation of a new health care FSA – or enhanced communication of an existing plan – can be used in tandem with health plan changes which require increased employee cost-sharing.

Such communications can help employees see how FSAs can lessen the financial burden of higher premiums, co-payments, or deductibles. Offering a health care FSA also gives an employer a hiring advantage over competitors without one.

So, from an employer’s perspective, is there a downside to offering a health care FSA? The one financial risk employers face from FSAs is the impact of an IRS regulation known as the “uniform coverage” or “insurance risk” rule. The rule requires the entire annual election amount (reduced by any reimbursements already made) be available to a health care FSA participant at all times during the plan year.

For example, let’s say an FSA participant elects to contribute $600 to the plan, and contributions are made through $50 monthly payroll deductions. In February, the participant would have contributed $100. The participant submits a substantiated claim for $500.. The entire claim must be paid. Now, let’s say the participant quits. The plan is out  $400.

IRS regulations do not permit plans to operate in a way which eliminates or substantially reduces this risk, but there are ways to moderate it and make the plan more effective for employers. First, however, consider how real the risk is for your workplace. Because employees make FSA contributions through payroll deductions, only terminating employees potentially present this type of risk to a plan. How high is your employee turnover? Unless turnover is an issue for an employer, the insurance risk rule is unlikely to present a significant problem.

Also remember, employees face their own risk as FSA participants. Amounts employees have elected to contribute to the plan cannot carry over to a subsequent plan year and must be forfeited, though the deadline has been softened  (see lower right-hand box for information about the change to the original FSA regulations).  Even small amounts unclaimed by participants can add up to offset losses the plan suffers from terminating participants who have been “over-reimbursed.” This (in addition to the FICA savings discussed above) is another reason why it is in the employer’s interest to keep plan participation as high as possible.

Here are some simple ways to lessen the chance a plan will suffer a large hit from a terminating employee:

• Setting a maximum amount an employee can contribute to the health care FSA.
• Limiting reimbursable expenses to exclude some types of big-dollar, elective expenses over which an employee can readily control the timing (such as multiple pairs of prescription eye-wear).
• Requiring a longer period of service for eligibility, since the highest turnover typically occurs among newest employees (note that while the law sets a maximum three-year period of service for eligibility, most plans require far less).

More extreme techniques to control the risk of loss include accelerating the frequency of contributions or requiring full-year participation (and withholding the balance of contributions due for the remainder of the plan year from all terminating participants). Such techniques should be considered more aggressive and fully explored before implementing. They are not necessary for most employers and are considered by some to stretch the legal limits of FSA operation.

Remember design constraints on the plan may run counter to encouraging employee participation and, for the vast majority of employers, a plan with healthy participation works effectively, both for the plan sponsor and participants.

© 2017