Overspent Health FSA Upon Termination of Employment and Life Event

Question:  Can a cafeteria plan require employees to continue health FSA contributions upon experiencing a mid-year life event if the account is overspent?

Compliance Team Response:

That clearly is not permitted where an employee terminates employment.  However, as discussed below, the rules appear to be different where the employee experiences any other mid-year permitted election change event.

Employer Cannot Recover Health FSA Contributions Upon Termination From Employment

Employers cannot recover any amount from an employee who terminates employment mid-year with an overspent health FSA.  That would risk disqualifying the entire Section 125 cafeteria plan, resulting in all elections becoming taxable to all employees.

Keep in mind that it is very common for employees to forfeit funds at the end of the year as a result of the use-it-or-lose-it rule.  In many cases, this can result in net experience gains to the plan despite the losses from employees who terminate mid-year with an overspent account.

FSA coverage (i.e., the ability to incur expenses that are reimbursable under the plan) generally ends as of the date of termination of employment or the end of the month following termination of employment.  There is typically a run-out period to submit claims incurred prior to the termination of coverage.  The employee may also have COBRA rights.

See our prior FAST for full details: https://www.theabdteam.com/blog/health-fsa-reimbursements-termination-employment/

Unclear Whether Employers Can Prevent Health FSA Reductions Upon Other Mid-Year Life Events

The Section 125 rules are not clear whether the uniform coverage rule for termination of employment also applies for a mid-year permitted election change event.  In other words, it is not clear whether a cafeteria plan that would otherwise permit the employee to revoke an election to contribute to the health FSA upon a life event can prevent the employee from doing so where the employee’s account is overspent.

The cafeteria plan for federal employees (the “FedFlex” Plan) is the best evidence for the argument that employers are permitted to recover any reimbursements exceeding the amount of contributions upon a life event.  The FedFlex plan states that a participant cannot reduce a FSA election below the amount already reimbursed for the plan year.  This prevents employees from using the permitted election change event as a pretext to stop making contributions on an overspent account.

Ultimately, this is best viewed a plan design issue.  It’s rare to see the cafeteria plan document’s written terms specifically address this scenario.  Assuming the plan terms don’t directly address the issue, it is likely fine for the employer to take either approach applied consistently.

The employer should consider the potential experience loss to the plan (theoretically up to $2,700 per participant in 2019) when making a determination.  The risk of experience losses already exists for employees terminating from employment, but it would be augmented by an approach that permits mid-year election changes to revoke or reduce health FSA contributions below the amount already reimbursed.

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Regulations

Prop. Treas. Reg. Sec. 1.125-5(d)(1):

(d) Uniform coverage rules applicable to health FSAs.

(1) Uniform coverage throughout coverage period—in general. The maximum amount of reimbursement from a health FSA must be available at all times during the period of coverage (properly reduced as of any particular time for prior reimbursements for the same period of coverage). Thus, the maximum amount of reimbursement at any particular time during the period of coverage cannot relate to the amount that has been contributed to the FSA at any particular time prior to the end of the plan year. Similarly, the payment schedule for the required amount for coverage under a health FSA may not be based on the rate or amount of covered claims incurred during the coverage period. Employees’ salary reduction payments must not be accelerated based on employees’ incurred claims and reimbursements.

IRS Chief Counsel Advice 201012060:

https://www.irs.gov/pub/irs-wd/1012060.pdf

The cafeteria plan rules require that a health FSA provide uniform coverage throughout the coverage period (which is the period when the employee is covered by the plan). See Proposed Treasury Regulations Section 1.125-5(d). Under the uniform coverage rules, the maximum amount of reimbursement from a health FSA must be available at all times during the coverage period. This means that the employee’s entire health FSA election is available from the first day of the plan year to reimburse qualified medical expenses incurred during the coverage period. The cafeteria plan may not, therefore, base its reimbursements to an employee on what that employee may have contributed up to any particular date, such as the date the employee is laid-off or terminated. Thus, if an employee’s reimbursements from the health FSA exceed his contributions to the health FSA at the time of lay-off or termination, the employer cannot recoup the difference from the employee.

The Federal Flexible Benefits “FedFlex” Plan:

https://www.opm.gov/healthcare-insurance/flexible-spending-accounts/reference-materials/fedflex.pdf

  1. No Covered Employee will be allowed to reduce his or her election for an HCFSA or DCFSA to a point where the total allotment for the Plan Year for such benefit is less than the amount already reimbursed for that Plan Year. In addition, any change in an election affecting the Covered Employee’s annual allotments to the HCFSA or DCFSA pursuant to this section also will change the Covered Employee’s benefits for the period of coverage remaining in the Plan Year. The Covered Employee’s benefits following an election change will be calculated by adding any balance (including a negative balance) remaining in the Covered Employee’s HCFSA or DCFSA as of the end of the portion of the Plan Year immediately preceding the change in election, to the total allotments scheduled to be made by the Covered Employee during the remainder of such Plan Year to each account, respectively.

 

Disclaimer: The intent of this analysis is to provide the recipient with general information regarding the status of, and/or potential concerns related to, the recipient’s current employee benefits issues. This analysis does not necessarily fully address the recipient’s specific issue, and it should not be construed as, nor is it intended to provide, legal advice. Furthermore, this message does not establish an attorney-client relationship.  Questions regarding specific issues should be addressed to the person(s) who provide legal advice to the recipient regarding employee benefits issues (e.g., the recipient’s general counsel or an attorney hired by the recipient who specializes in employee benefits law).

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