Health FSAs: 5 factors to consider for optimal program design

Health Flexible Spending Accounts (FSAs) continue to be a key workplace benefit offering that can help employees and their families manage the ever-increasing cost of medical, dental and vision care. Here are five Health FSA considerations for employers to consider for an optimal program that works for both the company and their employees.

1. Employers can choose a lower limit than max

The Internal Revenue Service (IRS) sets the annual maximum election, which is adjusted for inflation. The limit for plans that start in 2024 is $3,200.¹ Employers can choose a lower limit, but the election limit is a balancing act. Most organizations want to support employees with high out-of-pocket expenses by allowing them to elect as much as they need to pay those expenses with pre-tax funds. Employers also benefit from higher elections because they don’t pay federal payroll taxes (7.65% on incomes below $168,600 in 2024)¹ on employees’ elections.

A mandatory Health FSA feature is uniform coverage. This means, participating employees have access to their full election on the first day of the plan year — even though they pay level payroll deductions each pay period. If an employee ceases participation, for example, by leaving the company or losing eligibility by moving from full- to part-time employment — employers can’t recoup any excess of spending over funding for the year. Employers accept uniform coverage as part of the risk of offering the plan, just as employees accept the risk of forfeiting unused balances as part of their participation in the plan.

There is no minimum election in the tax code. Employers can also set a minimum election to enjoy enough payroll-tax savings to offset at least a meaningful portion of the annual account fee charged by the administrator.

2. Employers can contribute to employees’ Health FSAs

Employers are permitted under federal tax law to contribute to employees’ Health FSAs, though few do. Employees (even those who are healthy) may incur eligible expenses for contact lenses and solution, an occasional dental cavity, routine cost-sharing on the medical plan, or over-the-counter drugs and medicine to self-treat simple injuries, illnesses and conditions.

Offering even a small employer contribution — such as $100 to $200 — may help employees receive and appreciate the benefits of the Health FSA, even if they don’t add any money of their own. Employers could require an employee match to collect its contribution. The employer contribution doesn’t count against their election limit.

3. Employers can limit the risk of forfeiture

Most employers don’t want their employees to forfeit balances, even though the company retains those funds. The risk of forfeitures tends to reduce enrollment, and actual forfeitures prompt further reductions in future enrollment among employees who lose balances and co-workers who hear their stories.

Employers can add one of two (but not both) options to allow employees more time to spend their balances:

1. Carryover. Permit employees to carry over a portion of their unspent balances at the end of the year. The amount is limited to no more than 20% of the statutory maximum election. For Health FSA plans starting in 2024, the maximum carryover is $640.¹ Employers can set a lower carryover limit and set restrictions to manage program costs. For example, employees can roll over a balance only if they make an election for the following plan year.
    
2. Grace period. The maximum allowable grace period is two-and-a-half months after the plan year to allow participants additional time to spend that Health FSA plan year’s balances. Employees can monitor their spending and adjust the following year’s election to reflect the unused balance they can spend early during the next plan year.

Another benefit to employees: The grace period provides overlapping plan years. A participant with an expense greater than a single year’s election limit — like vision-correction surgery or orthodontia treatment — can schedule these services during the overlap period and spend both the prior year’s balance during the grace period and the new plan year’s balance on these higher-cost services.

Employers aren’t required to offer either option, but the risk is minimal since payroll deductions for balances available during the grace period and carried over into the new plan year have already been collected. The only financial risk is incurring monthly account fees with no payroll-tax savings offset if the participants don’t participate during the new plan year.

4. Employers determine the plan year

In most cases, a best practice is to align the Health FSA plan year with the medical plan year. That way, employees can react to changes in cost-sharing on the medical plan as they set their Health FSA election for the following year. A sudden change in projected expenses isn’t a qualifying event to adjust an election up or down during the Health FSA plan year.

With some business calendars, it may be beneficial to align the medical and Health FSA plan years.  Other organizations might choose to adopt a different model. For example, a school district with a fixed July 1 renewal date for the medical plan could consider holding the open-enrollment period for the medical plan and Health FSA simultaneously in mid-May, but not start the Health FSA until September, when the school year typically begins.

Employers can run a shorter (less than 12-month) plan year to align a new effective date to reflect a legitimate business need (such as in the example above). But a plan year of less than 12 months is an exception and reserved for purposes of a one-time plan year realignment.

5. Employers choose what to do with forfeited balances

When participants don’t spend their entire elections and file claims by the deadline, the unspent balances are forfeited to the plan sponsor. Here’s how employers can use those unspent elections:

• Offset plan expenses. Employers can use the forfeited funds to offset their plan expenses. Most administrators charge an annual fee and a monthly account fee to administer a Health FSA — payroll-tax savings offset much of this expense. A $1,000 election reduces payroll taxes paid by $76.50 in most cases, which is typically enough to offset the monthly account fee for that participant.
   
• Offset other employee-benefits expenses. Employers can direct forfeitures to fund other employee benefits, such as activities around open enrollment like meals and raffles or other benefits, such as tuition reimbursement or other insurance options. (Note: This income stream can vary from year to year, making it a less desirable option to fund ongoing coverage.)
   
• Return the funds to participants. Employers can’t return forfeited balances in proportion to the forfeiture (e.g., give participants their forfeited amounts back). But the total amount can be forfeited evenly across all participants. For example, if an employer has $2,000 in forfeitures and 50 employees participate the next year, each participant could receive an employer contribution of $40 ($2,000 divided by 50).

Conclusion

Though Health FSAs must meet certain prescriptive requirements under the federal tax code, there is flexibility to craft a program to meet both the employer’s and employees’ needs. It’s important for organizations to understand and apply this flexibility — and Voya is here to help employers design an optimal offering.

To learn more about Voya’s Health FSAs and other Health Account Solutions, contact your Voya representative.