The changes in Flexible Spending Account (FSA) rules are expected to impact employee participation in FSAs and spending on medical costs, according to industry experts.
In October 31, 2013, the IRS issued a modification to the “Use or Lose” provision. Previously, all funds in an FSA had to be used by the end of the plan year or they would be forfeited. With the October 2013 modification, employers were given the option of offering their employees the ability to Carry Over up to $500 in unused funds into the next plan year. If an employer offers a grace period-which allows employees to Carry Over funds for a specified amount of time into the following plan year, not exceeding 2 and a half months-the grace period must be eliminated before a Carry Over can be allowed. A plan cannot offer both options.
“The greatest deterrent for FSA enrollment has been the ‘Use or Lose’ rule,” says Renee Lutzen, Senior Director of Healthcare at Visa Inc. “The IRS modification of the rule is expected to result in increased FSA participation which will allow more employees to participate in the management of their healthcare spend without the fear of forfeiting up to $500 of their contributed monies, which they set aside specifically for healthcare costs.”
In addition to ensuring both employers and employees-if their employer selects a Carry Over option-are aware of the Carry Over option, managed care executives that are involved in administering benefits for employers/plans that include FSAs should ensure:
- Employers are compliant with all associated IRS compliance rules including the requirement for employers to amend their health FSA plan document to allow for the $500 Carry Over provision, in writing, on or before the last day of the plan year.
- Employers are aware of the requirement for the employer to announce the plan changes to employees before the end of the year;
- Eliminate a health FSA grace period before the Carry Over can be allowed.
“Consideration also needs to be given to how the Carry Over is handled in the event the employee moves to a tax-advantaged health savings plan,” Lutzen says. “Because a FSA is considered a health plan, only limited use FSAs-typically covering dental and vision-may be used with an HSA.”
The modification to allow a Carry Over is perceived as beneficial to the employee and the employer.
For the employee:
- Reduced risk – the ‘Use or Lose’ rule has been cited as the primary deterrent for FSA participation. A 2013 Mercer National Study on Employer-Sponsored Healthcare reported that while 85% of employers offer FSAs, only 20% to 22% of employees take advantage of this tax-advantaged benefit.
A Visa 2013 study – FSAs: Consumer Attitudes, Perceptions, and Behavior found that the average amount left in a FSA at the end of the 2012 plan year was $138.71.
“With the $500 carry over, the risk of forfeiture is greatly reduced and for someone who elects an FSA and contributes $500, it’s nearly a no-risk proposition,” Lutzen says.
- Greater control – “The $500 carry over means participants won’t be pressured to spend down balances before the plan year ends,” Lutzen says. “More people participating in FSAs means greater consumer participation in their healthcare as they manage how, when, and why their healthcare dollars will be spent.”
- Greater savings – Employee contributions to an FSA are made through pretax salary reductions which means someone who contributes $500 to a health FSA will save approximately $125 in taxes as reimbursements to pay qualified medical expenses are not taxed either.
“The $500 carry over does not impact the $2,500 FSA maximum contribution, so an employee could use up to $3,000 in a plan year to pay medical expenses if they had a $500 carry over from the previous plan year,” she says.
For the employer:
- Greater flexibility – The Carry Over can be adopted and communicated as part of the 2015 open enrollment season, giving employees who typically say ‘no’ to FSAs (because they don’t want to risk losing funds) a chance to open a basically risk-free $500 health FSA for 2015, according to Lutzen.
- Greater participation – “The Carry Over offers a safe and attractive option for those who have shied away from FSAs in the past,” she says. “By contributing $500, the participant can try out an FSA with basically no risk. They can then decide if they want to participate the following year and/or contribute more to their FSA once they are comfortable with how it works.”
- Greater savings – Employers do not pay the 7.65% FICA taxes on employee voluntary salary reduction contributions, so an employee election of $500 would save an employer a little more than $38 in tax savings and about $190 in tax savings on an election of the maximum allowable amount of $2,500, according to Lutzen. “These savings can be used to offset administrative expenses associated with offering this benefit,” she says