What Is A Health Flexible Spending Account? +9 More Employer FSA FAQs

Whether you are building a benefits program for the first time or have been thinking about ways to boost your offerings, you’ve likely come across a health Flexible Spending Account (FSA) as an option. That being said, you’re probably not an expert in FSAs just yet and could still use answers to some of your questions before taking any next steps. 

In this article, we’ll answer common questions about FSAs like, “What is a flexible spending account?” Additionally, we’ll get into how they work, what they cost, what the funds can be used for, and compliance requirements. After reading this, you’ll be prepared to decide if offering an FSA to your employees makes sense for your company.

What is a flexible spending account?

A health Flexible Spending Account (FSA), also called a flexible spending arrangement, is a pre-tax account employees put money into to pay for certain out-of-pocket healthcare costs. Employees choose the contribution amounts, which are deducted from their gross pay, reducing their taxable income for that year.

Employers may design their plans to allow them to make contributions to an employee’s FSA, as well but aren’t required to. We’ll discuss employer health FSA contributions in more detail in a bit.

How does an FSA work?

Employees can sign up for a health Flexible Spending Account during open enrollment. At that time, they’ll decide the contribution amounts they want deducted from each paycheck through a voluntary salary reduction agreement. It’s important to note that once a worker selects a contribution amount, they can’t change it unless there is a qualifying event mid-year. These events include a change in marital status, number of dependents, or employment status.

As we already mentioned, you as the employer can also make contributions, but the total can’t be more than the IRS maximums set each year. For 2023, that amount is $3,050, up $200 from last year. If employees are married, their spouses can also put up to $3,050 in an FSA with their employer.

Employees can use the funds in the FSAs to pay for certain medical expenses, which we’ll get into in more detail about shortly.

To get reimbursed for eligible costs, employees submit a claim (through you as their employer) with proof of the medical expense. You’ll need to set up procedures for substantiating these claims. If you use a third-party administrator, they may have a system for automatically approving funds. Either way, the reimbursement amounts are also tax-free.

Are HSAs and FSAs the same?

Both FSAs and HSAs are tax advantage plan types that allow employees to set aside money on a pre-tax basis to cover certain healthcare expenses. But there are key differences between them. For example, with an HSA, employees can only participate if they are enrolled in a qualifying high deductible health plan.

One other way the plans differ is that the contribution limits for HSAs are higher than the FSA limits. And, since HSA balances roll over from year to year, these accounts can be part of a longer term savings strategy.

Another difference is that with an HSA, employees can change their payroll deductions at any time; with a health Flexible Spending Account, employees must choose the amount they want to contribute at the beginning of the plan year; this can only be changed in the event of certain life events, which we just discussed.

What types of FSAs are there?

While we’re focusing here on health FSAs, there is another type: a dependent care FSA. A dependent care FSA operates like a health FSA but it can only cover qualified dependent care expenses for a child under age 13 or older dependents who are physically incapable of caring for themselves. Allowable expenses include things like preschool and nursery school and daycare.

If you choose, you can decide to offer a health FSA and dependent care FSA and employees can enroll in both.

What can a health FSA be used for?

There is a long list of products and services FSAs can be used for that are listed in IRS Publication 502. These include prescriptions, eyeglasses, dental care, chiropractors, home care, and ambulance services. While employees can use the funds to pay deductibles and copayments; they can’t use their FSA accounts to pay health insurance premiums.

Who can use an FSA?

It’s important to note that, in addition to your employees, they can also use the funds in their FSAs to cover qualified expenses for their spouse, if they’re married, as well as their dependents that are claimed on their tax return. This is true regardless of the health insurance they’re enrolled in.

What happens with unused FSA funds?

Unlike health savings accounts (HSAs), an unused FSA balance generally doesn’t roll over to the next year and is instead forfeited by the employee. That means the funds would revert back to you as the employer. There are two exceptions to this rule.

1. Grace period: You can design your plan to provide employees a grace period of up to 2 ½ months – until March 15 – so they can use the leftover funds into the new plan year.
2. Carryover: You can opt to allow up to a $610 rollover amount that they can move from one plan year to the next.

Whether you opt for either one of these options or not, it’s also a good idea to encourage workers to spend down their balance before the end of the year so they don’t risk losing it. Be sure to communicate to your team about the deadline for using the funds and what they can be used on.

How much does a health Flexible Spending Account cost employers?

While FSAs are a cost-effective option, you’ll still incur some expenses. These include:

1. Administration costs: FSAs are subject to ERISA so there are some requirements you’ll need to meet to be in compliance. These include creating plan documents, performing non-discrimination testing annually, processing claims, and more. If you decide you don’t have the resources or expertise in house to handle these tasks, a third-party administrator (TPA) will generally charge you an average of $5 per employee per month for FSA administration.
2. Plan set up fees: If you use a TPA to administer your health FSA, they’ll likely charge you anywhere from $150 to $1,500 to get your plan set up. This involves designing your FSA plan, which includes thinking about considerations like how much you may want to contribute as the employer, whether you plan to provide employees a debit card linked to their FSA, and if you want to include a grace period or carryover feature for unused funds. They’ll also handle enrollment and collect FSA election forms from employees.
3. Potential penalties: As we just mentioned, there are complex and technical rules governing health FSAs that can be challenging to follow. And if you don’t? You could face potential penalties. For example, if you make a wrong determination of what qualifies as an eligible expense, your FSA could be disqualified.

Why would a business offer an FSA?

While FSAs offer your employees important tax advantages and opportunities to use pre-tax dollars to pay for eligible health expenses, these accounts are also beneficial to your business. Some of the advantages you’ll realize if you add FSAs to your benefits package include:

• Greater employee satisfaction: By giving workers a way to lower their out-of-pocket healthcare costs and taxes, a health flexible spending account can increase employee satisfaction with your benefits package, a key driver of retention.
• Payroll tax savings: If you design your plan to allow employer contributions, then you’ll save the 7.65% of payroll tax for Social Security and Medicare on the amounts you contribute. Moreover, your contributions are tax deductible to your business.
• The potential to receive unused funds: Since employees who don’t use all the money in their FSA account by the end of the year or any carryover or grace period forfeit it to you, there’s a chance you’ll have access to some workers’ unused balances. You can then use these amounts to help cover the cost of FSA administration if you chose to use a TPA.

Are there FSA rules?

As we touched on earlier, there are rules governing FSAs that you’ll need to follow. The most common guidelines to be aware of include:

1. Creating plan documents, including creating a written plan document and providing a Summary Plan Description to participants.
2. Ensuring proper claim substantiation, which involves reviewing claimed medical expenses to ensure they’re eligible for reimbursement.
3. Managing unused funds, including any exceptions to the use it or lose it rule and what to do with remaining balances.
4. Adhering to contribution limits, which are subject to change every year by the IRS.
5. Limiting election changes to once a year unless an employee has a qualifying event.
6. Performing annual non-discrimination testing.
7. Ensuring ACA compliance by making sure your plan qualifies as an excepted benefit.
8. Filing Form 5500, required annually if your FSA has 100 or more participants.
9. Providing COBRA for qualified beneficiaries.
10. Meeting HIPAA requirements if you handle your own FSA administration since you’ll be reviewing claims and receipts for medical expenses.

It’s critical that you follow FSA rules and regulations or you risk fines. For example, if you don’t file a Form 5500, you may have to pay a Department of Labor fine of up to $2,400 a day plus IRS penalties. 

How do I know if an FSA is right for my business?

As you can see from these common questions, there are a lot of things to consider when it comes to offering a health flexible spending account to your employees. To decide if adding an FSA to your package is the right choice for your business, it’s a good idea to closely evaluate the benefits and drawbacks.