Employer Options for Forfeited FSA Funds

Compliance, Employee Benefits

A common issue at the end of a flexible spending arrangement (FSA) plan year is that employees have contributed more money to their FSA than they have spent. This leftover money can leave employers wondering what actions they need to take next. Fortunately for employers, there are several options for how to handle these unspent funds.

It is important to remember that a FSA cannot be used to defer compensation. This means that money that is contributed to a FSA must be spent during the year it was contributed or it is forfeited. This is known as the “Use It or Lose It” Rule. Unused dollars do not just disappear; rather the responsibility shifts to the employer as to how to use the forfeited money.

Options Available to Employers

When employee FSA dollars are forfeited, employers have options. What follows is a rundown of the options that employers have:

  • Reduce All Employee FSA Contributions: Employers can choose to leverage forfeited FSA money to reduce all employee FSA contributions while leaving the amount of FSA coverage unchanged. If the employer decides to use the forfeited FSA dollars to reduce employee contributions, an employee would be able to contribute less to the FSA while still receiving FSA funds up to amount elected. The forfeited FSA dollars are used to make up the difference between what employees contribute and the amount of money the FSA contains.
    • Employees with the same FSA contribution limit must receive uniform reductions in the amount of required FSA contributions.
  • Increase FSA Coverage for All: Employers can also choose to increase the amount of coverage provided under their FSA without requiring additional employee contributions. For example, an employer could increase the coverage of a $500 FSA to $520 without requiring employees to contribute more than $500.
    • This alternative may require changes to plan documents to allow for forfeited FSA money to be used to increase the FSA coverage limit beyond what would normally be allowed. The increased coverage amount can exceed the statutorily allowed limit ($3,200 in 2024).
  • Refund Money to All Employees: Employers have the option to return unspent FSA dollars to employees. An individual’s claim experience cannot be used as a factor to determine the refund amount an individual receives. This would mean that all participants would benefit from the refund equally. FSA dollars refunded to employees are subject to taxation.
  • Pay FSA Administration Expenses: Employers can use forfeited FSA funds to offset the costs of administering the program. For example, an employer could use the unspent money to pay third party vendors who administer the FSA on the employer’s behalf. Before selecting this option, employers should make sure their plan document does not prohibit the use of forfeited FSA money to pay administrative expenses.
  • Retain Dollars: In limited circumstances, employers can choose to retain the forfeited money for themselves. The deciding factor is whether the plan is subject to the Employee Retirement Income Security Act (ERISA). Most health FSAs are subject to ERISA with the major exceptions being FSAs offered by governmental and church entities. Conversely, most dependent care FSAs are not subject to ERISA, meaning an employer who sponsors a dependent care FSA could keep the forfeited money for themselves if state law does not prohibit it.
    • In sum, if the FSA is subject to ERISA, the employer, as plan sponsor, cannot legally retain the money for itself. However, if the FSA is not subject to ERISA, the plan sponsor can retain the forfeited FSA money for itself.

It is important to note that for all options, employers cannot take an individual employee’s claim experience from the prior year into account when setting up the plan. This rule allows for an equitable experience for all participants in the program.

Key Takeaway:

Employers have a number of options available to them when deciding what to do with forfeited FSA dollars. Employers should understand their options and work with their partners to implement the one which best fits their organizational goals.

The information provided is a summary of laws and regulations relating to employee benefit plan compliance. This information should not be construed as legal advice. In all cases, employers should consult with their own legal counsel.

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