What Happens to Unused FSA Funds?
Flexible Spending Accounts (FSAs) are a great option to help employees pay for their medical-related expenses. In the past the FSA had a “use it or lose” rule. Employees who had any money left in their FSA account at the end of the year would lose those funds. This begs the question: “Who gets forfeited FSA money?”
Rolling over FSA funds
Effective October 31, 2013, The IRS announced changes to the FSA rules for employees using those accounts.
Employers can now amend their Section 125 cafeteria plan to provide for the “carryover option” for the unused FSA funds of up to $500 to transfer from the end of one year to the next. Although the IRS allows a maximum amount of carryover of $500, a plan may specify a different lower maximum amount, or the plan sponsor may not allow carryover at all. The option for using the carryover would be in lieu of plans using a grace period.
Options for forfeited FSA funds
Although the carryover funds do not expire, the $500 maximum transfer still applies from year to year, and employers may still have to deal with unused FSA funds. If you’re offering an FSA to your employees, here are ways you can handle these forfeited funds in keeping with Internal Revenue Service regulations:
1. You can choose to defray the cost of reasonable administrative expenses associated with the FSA account. You can choose to pay the third-party administrator (TPA) with the funds, provided that:
- The FSA plan document does not prohibit payment to the TPA;
- Funds are not used to pay for FSA set-up fees or for a different plan; and
- The funds pay for administrative expenses that are directly related to the FSA.
2. You can reduce the annual FSA premium in the coming year for all eligible plan participants. This means you can reduce the participant’s payroll deductions by the amount you’re contributing.
3. You can increase the annual coverage amount for the next plan year, up to the IRS maximum election limit, as long as you don’t discriminate against participating employees.
4. You can distribute the forfeited funds as a cash refund to participating employees. This option may be tricky if you have to track down employees who were plan participants but left the company. Also, the cash will be considered taxable income and reported on Form W-2.
NOTE: Requirements for Options 2-4
If you want to pursue options 2-4, you must follow these rules:
- You must distribute money to employees on a reasonable and uniform basis (either equal amounts to each person, or on a weighted average based on each person’s level of contribution); and
- You cannot distribute forfeitures based on claims experience. For example, you can’t give more money to one employee just because they had more left in their account than another employee.
Feeling overwhelmed with the complexities of running payroll? Our Payroll Software does the heavy lifting for you when it comes to the regulations, requirements, and technical aspects of your payroll program. Give us a try for free today!
Updated and republished from the original publish date.