About 63% of businesses offer a flexible spending account (FSA). The popularity of these plans is due largely to their tax advantages. However, as an employer there are several other benefits of an FSA for both you and your employees that may make them an ideal addition to your package. What are they? Let’s find out.
In this article, we’ll discuss what an FSA is, how the plans work, and the benefits and potential downsides of these accounts. After reading this, you’ll be able to decide if an FSA may be right for your business.
What is an FSA?
An FSA is a pre-tax savings account that is owned and set up by employers for employees to cover qualified healthcare expenses such as prescription drugs, office visit copays, and dental and vision expenses.
The accounts are funded by voluntary salary reduction agreements, meaning, your workers select the amount they want withheld from their pay at the beginning of the year up to the IRS annual limit. For 2022, that limit is $2,850, increasing to $3,050 in 2023. Depending on your plan, you may also decide to contribute to the accounts.
FSA funds can then be withdrawn tax free for qualified purposes. Those that aren’t used at the end of the year are sent back to the employer unless the plan has a grace period or carryover feature.
It’s important to note that you can also offer a dependent care FSA that allows employees to set aside up to $5,000 pre-tax to cover qualified dependent care expenses like daycare and summer camps. However, for the purposes of this article, we’ll focus on healthcare FSAs.
What are the benefits of an FSA?
An FSA offers both you and your employees significant benefits. These include:
Employers
- Payroll tax savings: When you contribute to an employee’s FSA, you’ll avoid the 7.65% payroll tax for Social Security and Medicare (FICA) on the amount. In addition, your contributions are tax deductible.
- Employee satisfaction: By adding an FSA to your package, you’ll give employees a way to lower their out-of-pocket medical costs and their taxes, savings that can improve their satisfaction with your overall benefit offerings.
- Unused funds: If your employees don’t use all the funds in their accounts at the end of the year, the remaining will be sent back to you unless your plan has a grace period or carryover feature. You can put this amount towards the cost of administration if you choose to use an outsourced provider.
Employees
- Double tax advantages: Funds contributed to employees’ accounts are deducted from their pay before taxes, which lowers their taxable income. In addition, the funds withdrawn to pay for qualified medical expenses are not subject to tax.
- Comprehensive covered expenses: Funds can be used for a wide variety of purposes, including copayments and deductibles, prescription and over-the-counter drugs, menstrual products, blood sugar testing supplies, and medical equipment purchases..
- Family member benefit: The benefits of an FSA can be extended to an employee’s spouse and tax dependents, allowing them to use the funds as well – even if they’re enrolled in different medical insurance.
- Self-service: Employees can use a desktop or mobile app to complete tasks like checking balances and claims submissions. Plus, most FSAs are tied to debit cards so employees can pay for expenses directly rather than having to manually file for reimbursement.
Are there disadvantages of an FSA?
There are some potential drawbacks of an FSA, including:
Employers
- Compliance concerns: FSAs are subject to ERISA so there is additional documentation and operational compliance required such as plan documents, nondiscrimination testing, and more. Most employers choose to outsource ongoing management of the plans to a third-party administrator to alleviate this burden.
- HIPAA requirements: A healthcare FSA (other than one that’s self-administered with less than 50 participants) is deemed a group health plan and subject to HIPAA privacy standards around protected health information (PHI). If you’re administering your plan yourself, you’ll need to distribute a Notice of Privacy Practices, limit access to PHI, and implement procedures to protect it when reviewing claims or receipts for expenses.
- Potential penalties: If you decide to handle FSA administration inhouse, as we just mentioned, there are many technical and complex compliance requirements and, if you don’t get them right, it can cost you. For example, if you make a wrong determination about what qualifies as an eligible FSA expense, the entire FSA could be disqualified.
- Upfront annual election: Under the Uniform Coverage Rule, you’re required to reimburse expenses up to the participant’s annual election amount regardless of their account balance. So if they terminate employment, you can’t recoup the funds you reimbursed that exceed what the employee had contributed up to that point.
- Cost: If you choose to outsource the administration of an FSA, there’s a cost associated with that. You can expect to pay about $150 to $1,500 to set up an FSA. Then generally a third-party administrator will charge you an average $5 per employee per month fee.
Employees
- Use it or lose it feature: With an FSA, unused funds generally don’t roll over from year to year and are forfeited and returned to you as the employer unless your plan has a grace period or carryover. That means employees must plan at the beginning of the year how much they expect to spend on healthcare when they set their contributions.
- Limited election changes: With an FSA, employees can only set their contribution limit once, at the beginning of the plan year, unless they have a qualifying event such as a change in marital status, number of dependents, or employment status. Regardless of when the money is paid in, however, employees can access it at the start of the plan year.
- Contribution caps: The amount an employee can elect to contribute is set by the employer and subject to IRS regulations so if they have a lot of expected expenses, they may not have enough to cover them through this type of savings account. Keep in mind, however, that employer contributions generally don’t count towards the limit.
- Portability: Since employers own FSAs, they can’t be maintained when an employee no longer works for your company so they’ll lose any unspent funds in their FSA when they leave the business.
How to Decide if an FSA is Right for Your Company
While the significant benefits of an FSA may be appealing to your organization, there are also some potential drawbacks that you’ll want to consider carefully. As you weigh the pros and cons of an FSA for your company, you may want to understand a little more deeply how FSAs work. Read our next article to learn the rules you’ll need to follow to reap the benefits of pre-tax plans. For more details on what’s involved in administering these plans, read our next article on FSA administration for the steps required.