Best Practices on New Flexibility for Health FSAs

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“Some employees undoubtedly are concerned that they’ll lose money because of forces beyond their control, no matter how accurately they tried to project their expenses. If they forfeit balances because of a natural disaster, they’re less likely to participate in the future. . .”

William G. (Bill) Stuart

Director of Strategy and Compliance

June 11, 2020

In mid-May, the Internal Revenue Service issued guidance permitting employers to alter their Health FSA and Dependent Care FSA plans in response to the COVID-19 pandemic. Companies can extend deadlines to incur FSA claims, allow mid-year open-enrollment periods for prospective changes to medical coverage and FSAs, and increase the carryover of unused Health FSA balances into the following plan year.

You’ve probably read about these changes and perhaps attended a Webinar or two. So, you know the compliance piece. Let’s step back and assess whether you (employer) or your clients (benefits advisor) should take advantage of any or all of these measures.

Extending the Deadline to Incur Claims

Rules Change: If the plan year or grace period includes at least one day in 2020 during which a participant can incur expenses, an employer can extend the deadline to incur claims to as late as December 31, 2020, for both Health FSA and Dependent Care FSA. Employers can treat each FSA plan differently (for example, extending the period to incur claims on the Health FSA but not the Dependent Care FSA). And they can choose to end the extended period prior to Dec.ember 31.

Benefit to Participants: Participants who aren’t able to spend their elections due to the effects of the pandemic have additional time to spend their elections. This relief is especially welcome to Health FSA participants who’ve had medical appointments and procedures postponed or cancelled since March. If their plan year ends in June, they may not be able to reschedule the appointment in time.

This flexibility helps Dependent Care FSA participants as well. But they enjoy more Permitted Election Changes (often called status changes or qualifying events) that allow them to adjust their elections prospectively for pandemic-related disruptions, including change in work location (office to home), change in hours, or lack of availability of day care. Those situations are not Permitted Election Changes for a Health FSA.

This flexibility will restore employee confidence in the program. Some employees undoubtedly are concerned that they’ll lose money because of forces beyond their control, no matter how accurately they tried to project their expenses. If they forfeit balances because of a natural disaster, they’re less likely to participate in the future, which will hurt them (no tax benefits) and the company (no payroll tax savings when employees don’t participate). And they may discourage co-workers from participating.

Risks to Employer: Employers face little risk in extending the period to incur claims. The extension doesn’t change the rate of payroll deductions. Thus, employees will pay their election in full after the 12-month plan year, so employers don’t face the risk of employees’ spending more than they’ve deposited and then leaving employment. Employers also will experience lower forfeitures than they might have when the pandemic disrupted participants’ spending plans toward the end of the plan year. But that shouldn’t be an employer strategy.

Also, extending the period to incur claims delays the administrator’s closing the plan, reconciling all activity, and delivering a final activity report (and perhaps some founds on balance) to the company. But the prior Department of Labor guidance stops the clock on any claims run-out period that includes March 1 or later, so must plans must remain open indefinitely for that reason.

Special Risk: There is one potential segment of the employee population that may be affected by an extended period to incur claims. Under Health Savings Account eligibility rules, an employee who carries any funds into a general Health FSA grace period is disqualified from opening and funding an account until the first day of the first month after the end of the grace period (e.g., April 1 for a calendar-year general Health FSA plan with a grace period). The extension of the period to incur claims disqualifies those employees until the end of the extended period (as late as December 31, 2020).

Employees who carried a balance into the grace period and then made or received contributions to their account on or after April 1 won’t be able to open or fund a Health Savings Account in 2020, even if they exhaust their general Health FSA balance well before the end of 2020.

Benefit Strategies Best Practice: Employers should review their situation carefully, particularly if they have a Health Savings Account program that’s either new or experienced a sharp rise in participation during the last open enrollment. Otherwise, they and their employees face little risk and a lot of upside by extending the period to incur claims. But be sure to check with the plan administrator about monthly fees. Benefit Strategies will charge a monthly account fee for any participant who carries a balance of more than $5 into the extended period to incur claims and hasn’t signed up for the following year’s plan. Other administrators may charge double fees to administer two plan years at once.

Special Enrollment Period

Rules Change: The new IRS guidance also permits employers to offer a special mid-year enrollment period during which employees can prospectively enroll in, disenroll from, or change an election to a  Health FSA or Dependent Care FSA (and start, stop, or change their enrollment in a medical plan sponsored by the company).

Benefit to Participants: A special enrollment period gives employees a do-over. They can make changes to their plan elections, whether their spending plans were disrupted by the pandemic or they have another reason (like a new diagnosis or lower-than-anticipated costs to treat a condition) to start or stop their participation or change their election up or down. They are less likely to forfeit funds if their election was too high and will receive tax benefits that they wouldn’t receive absent this special enrollment if their elections were too low.

Risks to Employer: Offering a mid-year special enrollment for a Health FSA poses some risk to employers. Under the concept of uniform coverage, participants have access to their full Health FSA election at any point during the plan year. They can spend their entire election early in the year and leave their employment, and the employer must cover the difference between what they spent and contributed. Employers who allow a special enrollment face this risk a second time, as employees who enroll initially or suddenly increase their elections can spend their elections and depart, leaving a deficit that the employer must cover.

Every company that offers a Health FSA assumes this risk. A special enrollment exposes the employer to this risk twice during the plan year. But the risk is limited to a Health FSA election.

Benefit Strategies Best Practice: The pandemic has changed many people’s lives since March. Many of the best-laid plans were shattered with the health, social, and financial disruption that COVID-19 has caused. Giving employees an opportunity to reassess their health and dependent-care needs helps them adjust their participation and elections to this new reality. We recommend that employers take a hard look at offering this flexibility to their employees.

The guidance doesn’t set any limits to a special election period. In theory, companies could allow employees to make prospective changes to enroll, disenroll, or change elections through the end of 2020. We recommend a short period, perhaps two weeks. And the sooner the better, since changes affect future deductions and spending.

Increase the Carryover to $550

Employers can choose one of two approaches to allow participants to continue to spend Health FSA elections after the end of the 12-month plan year. Our clients are nearly evenly split on which approach they take.

  • Grace period. Participants have a limited amount of time to spend an unlimited balance. This extender allows participants an additional two months and 15 days to incur expenses that they can reimburse from that year’s plan. They’re not limited in how much of their election they carry into the grace period. The grace period isn’t affected by recent legislative and administrative changes.

 Carryover of unused balances. Participants have an unlimited amount of time to spend a limited balance. Prior to recent changes in the law, participants could carry no more than $500 to spend during the following plan year, or the year after that.

Rules Change: Recent regulatory changes (see IRS Notice 2020-33) [  ] allows employers to increase the carryover amount to $550. And in future years, the carryover limit will be indexed to the maximum election amount (which increases in $50 increments to reflect annual changes in the cost of living).

Plans that begin in 2020 can offer the higher carryover amount. If the plan has started, employers can amend plan documents and notify participants of the change. If it hasn’t started yet, it’s incorporated into our implementation/renewal questionnaire.

Benefit to Participants: Employees with large balances – whether due to poor planning, unexpectedly good health, or factors beyond their control – can carry additional balances into the following plan year rather than forfeit up to $50.

Risks to Employer: The company faces no financial risk – unless it views lower employee forfeitures as a negative event. Employees have paid their election in full through payroll deductions, so employers face no financial risk allowing them to carry over an additional $50 into the following plan year.

 

Benefit Strategies Best Practice: Increase the carryover limit to $550 for plans that begin in 2020, and continue to allow carryover up to the new limit in future years. Participants have already paid their full election through pre-tax payroll deductions, so employers face no risk. The only possible downsides to the company are that (1) it may incur account fees if the employee hasn’t made an election in the new plan year and (2) it receives less in forfeited funds. But employers who mourn the loss of $50 less in forfeited employee elections aren’t offering a Health FSA for the right reasons.

What We’re Reading

Are medical premiums tax-deductible when you’re out of work? Maybe, and within limits. But most of today’s laid-off workers Health Savings Account owners receive the full tax benefit. Learn more here.

When Health FSA and medical coverage anniversaries don’t align, potential Health Savings Account participants find themselves in a bind. But new federal guidance may ease the pain for employees – but only if their companies act quickly. Learn more in the most recent issue of my HSA Monday Mythbuster column, published weekly on LinkedIn.

 

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