While Health Care Flexible Spending Accounts (FSAs) offer tax-saving benefits to employees, they also can provide tremendous advantages to employers that sponsor them. Salary-reduction contributions that employees make to an FSA are not subject to Social Security and Medicare (FICA) taxes. Thus, employers save their 7.65% FICA contribution on the dollars that employees contribute to an FSA. If FSA participation is high, FICA savings can be substantial. Even small amounts of savings are “true” savings, since a health care FSA can be a no-cost benefit for the employer to offer: Typically, an employer makes no contribution to the plan and can pass on any associated administrative costs to employees.
Health care FSAs offer employers strategic advantages, too. With seemingly ever-rising health care costs, implementation of a new health care FSA — or enhanced communication of an existing plan — can be used in tandem with health plan changes that 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, a fact that will become more important as the economy improves and unemployment rates decrease.
So, from an employer’s perspective, is there any downside in 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 that 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, if an FSA participant elects to contribute $600 to the plan, and contributions are made through monthly payroll deduction, in February the participant would have contributed $100. The participant submits a substantiated claim for $500. The claim is paid, and the participant quits. The plan is out $400.
IRS regulations do not permit plans to operate in a way that eliminates or substantially reduces this risk, but there are ways to moderate it, making the plan more effective for employers. First, however, consider how real the risk is for your workplace. Because employees make FSA contributions through payroll deduction, 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 that employees face their own risk as FSA participants, that of forfeitures. Amounts employees have elected to contribute to the plan cannot carry over to a subsequent plan year. Even small amounts unclaimed by participants can add up to offset any 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. Briefly, techniques that can enhance participation include maintaining frequent and effective communications that show employees the value of participation; offering easy tools for employees to enroll or obtain information about the plan; and facilitating employees’ claim filing (this could include use of stored-value debit-type cards for employees to use in making their FSA-related purchases or payments).
Beyond these, simple ways to lessen the chances that a plan will suffer a large hit from a terminating employee include setting a maximum amount that 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 eyewear); and 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 that design constraints on the plan might run counter to encouraging employee participation and, for the vast majority of employers, a plan with healthy participation will work effectively, both for the plan sponsor and participants.