By William G. (Bill) Stuart
Director of Strategy and Compliance
Dec. 22, 2016
Health FSAs are pretty well understood by employers and benefit advisors. They’ve been in place since federal tax reform and have changed little during the intervening three decades. For that reason, Health FSA participation hasn’t grown much in recent years. The only real sources of growth are (1) increased growth of the labor market, which has been a challenge during the last decade, (2) increased participation among employees who would benefit from the cash-flow and tax advantages of participating and (3) increased plan sponsorship by employers who don’t currently offer a program.
While most readers understand Health FSAs generally, some nuances aren’t as well understood as they should be. Employers, benefits advisors and employees who understand the points below have the equivalent of a master’s degree in Health FSAs. These employers and benefits advisors tend to give employees good direction when questioned. The employees who understand these concepts tend to enroll in Health FSAs and make larger elections than those who don’t grasp this financial benefits of Health FSAs.
Take a victory lap if you already know all the information below or now grasp it and its importance to understanding Health FSAs.
Health FSAs are notional accounts. Notional account simply means that it’s a bookkeeping entry. When an employee makes a $1,000 election to a Health FSA, the employer doesn’t send the administrator $1,000. Rather, the administrator in effect extends a line of credit to the participating employee. When participants submit claims or swipe their debit cards for eligible expenses, Benefit Strategies pays the claims and then invoices employers weekly for claims paid the prior week. (Some administrators require a working balance from which they pay claims and then invoice employers to replenish the working balance.)
Participants have a claim to their election only to reimburse eligible expenses as defined by the Internal Revenue Service (IRS). They can’t withdraw funds for other purposes, as they can with Health Savings Accounts (HSAs) or employer-sponsored qualified retirement plans like 401(k) plans. Health FSA elections don’t constitute financial assets that a participant would list on a financial disclosure form.
Health FSAs are medical plans. We don’t think of a Health FSA as a medical plan, but the IRS does. When we see it in this light, some of the rules around the plan make more sense. A Health FSA is a self-insured, limited-benefit medical plan. Self-insured means that the employer, rather than a traditional insurance company, is responsible for paying claims and assumes claims risk. Limited-benefit means that the plan has a maximum value (the amount of the employee election), beyond which the employer has no additional claims liability.
The IRS sets a limit on employee elections ($2,600 for 2017). Employers can set a lower limit if they wish. Each employee who enrolls in a Health FSA determines her benefit limit, which equals her election. Health FSA are unlike other medical plans in that each enrolled participant sets a personal benefit limit.
Participants’ payroll deductions constitute the premiums paid to enroll in this medical plan. Those payroll deductions are in equal amounts throughout the year regardless of how much of the benefit the participant accesses at a given point in the plan year – just like a major medical plan. Participants who pay more in premiums than they receive in benefits don’t have access to the difference – just like a major medical plan. Instead, they forfeit the balance. And participants who spend more than they have paid in premiums and then leave employment leave their employer on the hook for the difference between benefit received and premium paid – just like a major medical plan.
Now that you see a Health FSA in this light, do uniform coverage (employees’ right to spend their entire election at any point in the plan year) and forfeiture of unused balances make more sense?
Health FSAs cover family members. Medical insurance plans may deny coverage to some individuals who live with an employee, including a domestic partner and possibly even a spouse if he or she can access coverage through an employer. Those eligibility rules are set by the federal government, the state government in which the policy is issued, the insurer and, with some discretion, the employer.
By contrast, Health FSA eligibility rules are set by the federal government. Claims incurred by a domestic partner or ex-spouses aren’t eligible for reimbursement through an employee’s Health FSA, even if those individuals are covered on the major medical plan. As with other medical plans under the Affordable Care Act (ACA), eligible expenses incurred by a participant’s children to age 26 can be reimbursed from a Health FSA, even if the children aren’t covered on the participant’s major medical plan . . . even if they have their own major medical coverage . . . even if the children have their own Health FSA . . . and even if they’re married and covered on a spouse’s major medical plan or Health FSA.
Former employees may have COBRA rights to their Health FSA. This is a tricky topic, with nuances beyond the scope of this article. Here’s a quick summary of the rules: Participants who have spent more from their account then they’ve contributed in payroll deductions at the time that their employment is terminated do not have the right to continue their Health FSA. Those who have paid in more than they’ve received in reimbursements and are COBRA-eligible generally do have a right to continue their Health FSA.
Mileage and parking are eligible expenses. That’s right – Health FSA participants can reimburse reasonable travel and parking expenses directly related to their incurring eligible expenses. For example, a participant can reimburse mileage (at a rate set annually by the IRS – it’s 19 cents per mile in 2016 and drops to 17 cents per mile in 2017) to and from a physician visit and the cost of parking to take her child to see a specialist at a Boston teaching hospital.
Here’s one trick that’s perfectly legitimate (and that I’ve used). Say you need regular care – physical therapy, chiropractic care or acupuncture (my particular example). You can choose a provider near where you live or near work. If you choose one near work, you can reimburse your mileage between your home and your practitioner. In effect, you can reimburse the cost of your commute – an expense that otherwise isn’t deductible.
Individuals and families may be able to elect more than $2,600 in 2017. The annual limit on Health FSA elections is per participant per plan. Let me illustrate: I elected to receive $2,600 in my 2017 pay tax-free through my Health FSA. My wife, who’s benefit-eligible with her employer and declined medical insurance (she’s covered on my policy) also made a $2,600 election to her 2017 Health FSA. With our combined Health FSAs, we will have access to the full $5,200 in early January and will have saved more than $1,500 in federal and state income taxes and federal payroll taxes.
We’re limited to no more than $2,600 per plan (or lower, if the employer chose a lower limit), but because we enrolled in multiple plans and are two different people, we had access to more than one $2,600 limit. This concept is important to couples, individuals who change jobs and individuals who work more than one job and are eligible for benefits with more than one employer. Even if spouses work for the same employer, each working spouse – as a separate participant – can elect up to the maximum.
Also, note that the $2,600 limit per participant per plan applies to employee elections for that year only. Employer contributions to Health FSAs (allowed under federal tax law, but not common) and employee rollover of unused funds (allowed up to $500 if the employer elects this option) don’t count against the $2,600 limit. So, an employee who rolled over $500 and had his employer give all employees a portion of their annual compensation in the form of a $500 employer contribution to the Health FSA could have access to $3,600 to spend during the plan year.
Important note: The Dependent Care FSA limit of $5,000 ($2,500 if filing income taxes separately) is a limit per family per calendar year. Spouses and individuals who hold more than one job can’t “double dip” on that benefit. And as many readers are aware, that $5,000 limit isn’t indexed. It’s hard-wired into the 1986 federal tax reform and won’t change without a change in the law passed by Congress and signed by the president.
To learn more about Health FSAs, we recommend IRS Publication 969, printed annually. This easy-to-read guide summarizes rules for Health FSAs, Health Reimbursement Arrangements and Health Savings Accounts. The IRS will publish a new version of this document in January 2017 to assist taxpayers in completing their 2016 personal federal income tax returns.
What we’re reading
A growing consensus among Republicans is to attack the ACA by repealing it this winter and keeping the law in place for up to three years while Congress works on an alternative. Bob Laszewski, whose thoughts we’ve shared previously in this space, argues that this strategy ignores a fundamental reality: Insurers are unlikely to continue to lose money in the public marketplaces for up to three more years in the hopes that the new plan will be better for them financially.
Sally Pipes of the Pacific Research Institute warns that some misconceptions may interfere with a meaningful debate on new directions for reform. She lists those misconceptions here .
Devon Herrick at the National Center for Policy Analysis is one of our favorite thinkers and writers on medical economics. In this brief October commentary, he explains in layman’s terms how the 21st Century Cures Act, passed overwhelmingly in Congress and signed into law last week by President Obama, will play a small role in increasing patient access to and reducing the cost of some prescription drugs.