“The real fear should be low elections that participants spend well before the end of the plan year. In that case, participants have no forfeited balances, but they lose money by paying for eligible items with after-tax funds once they exhaust their low elections. Psychologically, not gaining something (additional tax advantages, which result in more spendable income) is less terrifying than losing something (forfeited balances).”
William G. (Bill) Stuart
Director of Strategy and Compliance
August 17, 2017
It’s estimated that more than 100 million Americans receive benefits from tax-advantaged medical reimbursement plans; Health Flexible Spending Arrangements (Health FSAs), Health Reimbursement Arrangements (HRAs) and Health Savings Accounts (HSAs). This figure includes both employees who enroll in these programs and family members whose expenses are eligible for tax-free reimbursements.
Among this 100 million-plus, more than half participate in an employer’s Health FSA program. That’s a lot. Yet in most companies that offer the program, typically between a quarter and a third of employees choose to receive a portion of their income in an account from which they can reimburse medical, dental, vision and certain over-the-counter expenses tax-free.
Items eligible for reimbursement include office visit and prescription drug copays, deductibles and coinsurance. Services not typically covered by medical insurance, like hearing aids, foot orthotics and acupuncture; most dental services, ranging from fluoride treatments and fillings to implants, crowns, periodontic and endodontic procedures, prescription sunglasses and glasses, contact lenses and solution and vision-correction surgery and over-the-counter equipment and supplies (plus OTC drugs and medicine with a valid prescription).
That’s a lot of services, and only the healthiest individuals are able to avoid these expenses entirely. In fact, it’s not uncommon for even individuals who use their medical insurance benefits sparingly to have a prescription drug with a $25 monthly copay ($300 per year), perhaps a dental filling (another $120 out-of-pocket) and a new pair of glasses or disposable contact lenses (another $100 to $300).
The Benefits of Health FSA Participation
Health FSA participants cite two main reasons for enrolling in the program:
Tax savings: Elections are made on a pre-tax basis, which means that no federal or state (if applicable) income taxes or federal payroll taxes are applied to the funds. Thus, for every $100 that a participating employee elects, she reduces her take-home pay by about $70. Meanwhile, the full $100 is placed in her Health FSA.
Cash flow: A participant’s full election is available at the beginning of the plan year. In other words, if the plan runs on the calendar year and a participant elects the full $2,600 (IRS maximum in 2017), she can spend $2,600 in early January when she undergoes extensive dental work, has her braces installed or undergoes vision-correction surgery. Even if she uses her entire election early, she still funds her account with the same payroll deduction each pay period; in this case, about $100 per biweekly paycheck. In effect, she receives a tax-free $2,600 loan from her employer that she pays back interest-free in equal installments.
Why Doesn’t Everyone Participate?
Most employees have sufficient eligible out-of-pocket expenses to justify participation in the program. Employees receive a tax break on any amount that they elect, whether it’s $100 or $2,600. For employers who choose to pay the administrative fees, any election above about $700 most likely results in employer payroll tax savings in excess of account admin fees.
Most employees easily reach $700 in eligible out-of-pocket expenses. That’s one drug with a $40 copay and a pair of bifocals, or the patient’s share of a single dental filling and a crown, or a monthly chiropractic visit not covered by insurance. It’s one drug with a $25 monthly copay, six $25 copays for visits to the PCP and five $50 copay visits to specialists, or an expensive pair of glasses and 20% coinsurance on a C-PAP machine. In other words, there are a lot of ways that even fairly healthy employees can reach $700 in eligible expenses, especially if they have families and thus more individuals accumulating eligible expenses.
Yet typically fewer than one-third of employees who could enjoy tax savings by participating in a Health FSA actually do so. Why is the figure so low?
VISA polls a number of cardholders annually to determine whether or not they participate in a Health FSA and to gauge their views on the accounts. And the results are fairly consistent year-to-year. In 2016, the top five reasons (feel like we’re playing Family Feud?) that employees who would benefit don’t do so are:
Fear of forfeitures (67%): This fear tops the list year after year, and that result is consistent with the conversations that we’ve all had with employees. A key feature of a Health FSA , like any other self-insured medical plan, is that participants don’t receive a refund of their premiums (payroll deductions) if their premiums are greater than their reimbursements. In other words, they forfeit unused balances.
The truth is that very few participants actually forfeit balances. In the VISA survey, the self-reported rates of forfeitures (of any amount) were 2% in 2015 and 4% in 2016. Why so few?
First, most participants low-ball their election amounts, either out of fear of forfeiting unused balances or not tallying all anticipated eligible expenses that they expect to incur during the year. They usually deplete their balances well before the end of the plan year.
Second, two modifications to Health FSAs introduced during the last decade reduce the actual incidence of forfeitures. Under the grace-period provision, employers can extend the plan year up to an additional two and a half months during which participants can continue to incur expenses and spend their elections. The rollover provision allows employers to roll over up to $500 of each participant’s unspent balances into the following plan year.
The real fear should be low elections that participants spend well before the end of the plan year. In that case, participants have no forfeited balances, but they lose money by paying for eligible items with after-tax funds once they exhaust their low elections. Psychologically, not gaining something (additional tax advantages, which result in more spendable income) is less terrifying than losing something (forfeited balances). This phenomenon is true even when participants forfeit less than 30% of their elections (and thus are losing money that they otherwise pay in taxes).
TPAs, benefits advisors and employers can do more to highlight to prospective participants the financial impact of not participating or not electing enough. Here are two suggestions:
Auto dealers send checks for $1,500 that can be cashed only by purchasing a new car. Employers can give each employee a coupon for 30% off all eligible purchases (and list some of those eligible expenses), good at any participating merchant and reusable. Who doesn’t love a bargain? Note in bold letters that the coupon is good only for participants in the company’s Health FSA program.
Pull three $100 bills out of your wallet when describing the Health FSA. Let employees see the additional income that they can spend if they elect $1,000 into their Health FSAs.
Not enough eligible expenses (45%): This high number reflects either confusion about the range of eligible expenses (far beyond medical-plan cost-sharing) or a gross underestimation of total eligible expenses (outlined above). Particularly with today’s higher medical deductibles and increased cost-sharing for prescription drugs, it’s difficult to imagine 45% of the population’s being right about not having enough eligible expenses to participate and save via tax savings roughly 30% on every purchase of an eligible expense.
TPAs, benefits advisors and employers can guide potential participants by providing a simple worksheet – either paper or an online calculator (better, since it reduces the potential for math errors) – for employees to complete. They can list their projected number of office visits and prescriptions, with an adjacent column showing the copay. They can add their, optical purchase and, dental expenses, as well as medical cost-sharing, to tally total potential eligible expenses. The result of this exercise usually is consistent from employee to employee: They have higher expenses than they thought and thus benefit more financially from participating than they imagined.
Paperwork hassle (35%): Survey respondents cited the hassle of Health FSAs as another reason that they don’t participate. This sentiment clearly refers to the requirement that reimbursements be limited to eligible expenses. Prior to the middle of the last decade, most participants had to purchase an item with personal funds (in some cases negating the cash-flow advantage that Health FSAs offer) and then submit a claim form with documentation to verify that the purchase was an eligible expense. This process provided 100% substantiation but lacked the convenience of drawing funds directly from the Health FSA.
Today, most transactions are completed with debit cards tied directly to the Health FSA, a feature that makes the plans super convenient. The problem arises when trying to determine whether an expense paid with the card is eligible for reimbursement. The cards themselves are restricted by merchant code to reduce the likelihood that they’re used for ineligible expenses. Every type of business (restaurant, pharmacy, gas station, dentist, theater box office, optical shop) has a merchant code that it associates with its debit card machine. Health FSAs debit cards are coded to work at pharmacies, hospitals, physician and chiropractor office, among other locations. Thus, the card won’t work when a participant presents it at a furniture outlet, clothing store or coffee shop.
The problem is that not everything offered for sale at an optical shop, dentist office or even medical facility is an eligible expense. For example, teeth whitening, non-prescription sunglasses and cosmetic injections of botulinum toxin (as opposed to FDA-approved indications) are sold at allowable merchants but aren’t eligible expenses.
The IRS reduces the hassle factor by allowing third-party administrators to auto-substantiate the following expenses:
- Multiples of medical plan copays (typically office visits)
- Recurring expenses (like chiropractic and orthodontic visits) once the provider and amount is substantiated once
- Expenses with instant adjudication, such as pharmacy claims
- Individual items coded through the Inventory Information Approval System (IIAS), the system that allows individuals to charge bandages at the pharmacy but leaves a balance for a soda that a consumer must purchase with another means of payment
- Purchases at stores like online and specialized drug stores in which eligible items constitute at least 90% of total dollar sales
These provisions allow most TPAs to auto-adjudicate between 75% and 85% of all transactions. Typical transactions that fall outside these parameters are purchases at dental offices and optical shops, as well as deductible and coinsurance expenses under the medical plan.
TPAs, benefits advisors and employers can set reasonable expectations in advance. Participants should create a folder to hold all paperwork associated with debit-card transactions (documentation that shows the date of purchase and item purchased, not merely a non-descriptive cash-register tape). That way, when the TPA requests documentation, the participant can refer to the folder and send the document, typically Through a mobile device’s camera using a TPAs mobile app, by fax, as a PDF document or photo attached to an e-mail or by USPS.
Too complicated (30%): These respondents most likely lack some basic financial literary. A Health FSA is a simpler financial account than a savings or checking account, though it does require a basic knowledge of what expenses are eligible (or where to locate the typical TPA’s one-page alphabetized summary of eligible expenses).
TPAs need to distribute one-page lists of common eligible expenses, and benefits advisors and employers need to make employees aware of these resources. Also, employees need to hear testimonials from co-workers about how easy it is to manage a Health FSA, particularly when using the debit card and saving documentation (detailed optical-shop receipts, detailed dental invoices, medical Explanations of Benefits) in a readily accessible folder. In most cases, the expenses that need to be substantiated are big-ticket items (few of them) with documentation either online (medical EoBs) or easily retrievable from a dentist or optical shop.
Not sure they have the benefit (28%): This is disheartening to anyone; TPA, benefit advisor, employer associated with Health FSAs. More than a quarter of employees don’t even know whether their employer offers a Health FSA program. Let’s say half their employers do. That means that 14% of workers who could save money by participating don’t make an election because they don’t know that their employer offers this program. We have let these people down.
TPAs, benefits advisors and employers can deliver education throughout the year. Health FSA success stories (“My daughter had a $2,400 dental implant in early January. I paid with my Health FSA and received a $500 prompt-pay discount because I could access the entire election early in the plan year.” By the way, a true story from my family’s experience.) in the company internal newsletter and more focus on the plan during open enrollment.
Bottom line: Health FSAs benefit employees (tax savings and immediate access to elections) and employers (no payroll taxes on elections and employees in effect give themselves a raise). It also helps providers (more likely to be paid). They’re a win-win-win proposition. Anything that we do to increase enrollment represents a valuable service that we, benefits advisors, employers, third-party administrators can offer.
What We’re Reading
HSAs continue to receive positive coverage in the popular press as an ideal retirement-savings account. Read one example here.
What are the premium trends in the 2018 ACA marketplaces? The Kaiser Family Foundation offers an assessment.
Although insurers haven’t finalized their 2018 ACA marketplace participation yet (their deadline is Sept. 27), it’s clear that consumers in the individual market will have fewer choices of insurers and plans next year. And since Congress is on break until Labor Day, a comprehensive response isn’t possible. One approach that’s beginning to gain steam is to offer Medicare to the under-65 population in counties with limited insurer participation. Here’s one group’s argument in favor of this approach. You’re sure to hear a lot more about this idea in September.