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Utilizing the Gains from Our FSA Plan

What May Be Done with The Gains I Received from Our FSA Plan?

From time to time, an employer will find that the Health FSA plan they offer will experience gains for a plan year. If the contributions exceed the reimbursements for that plan year, the plan will see a gain. Some call it forfeitures. If this money was not reimbursed during the plan year, or during the grace period (if applicable), or the carryover (if applicable), the money is forfeited back to the employer. While considering these possibilities, be aware that both IRS and ERISA requirements must be considered. Health FSAs sponsored by certain governmental and church employers generally are not subject to ERISA.

In the sections below, I will discuss the permissible uses for experience gains resulting from health FSA forfeitures:

    • Forfeitures may be used to offset experience losses for the same year. This is the simplest way to handle forfeitures. However, if the forfeitures for a plan year exceed the plan’s experience losses, I have shown some other permissible uses for the forfeitures below.
    • Reduce required salary reduction amounts for the immediately following plan year.
      • The salary reduction must come in the plan year immediately following the gain. For example, a $500 health FSA for the next year might only require the employee to contribute $480.
      • The regulations are unclear if the gains may be divided up between only those who participated during the previous year, or among all employees participating in the current year. However, they clearly must be reasonable and uniform.
    • Return cash to the employees on a reasonable and uniform basis.
      • For example, an employer has 1,200 employees on the health FSA. For one plan year, 1,000 employees elect levels of coverage under the FSA. For that year, the FSA has a gain of $5,000 (contributions for the year exceed reimbursed claims plus administration costs by $5,000). The $5,000 gain may be returned to all employees who elected coverage for the plan year, (i.e. $5 per participant) or weighted to reflect the employees’ elected levels of coverage. In other words, the more they elect, the more they would receive of the gains. It is vital that they would be weighted by the same percentage of coverage to not be found discriminatory. Disbursement of the gains can never be decided on how much money the employees left unused in their accounts.
        • This option is rarely used, partly because of concerns about whether cash refunds may be made only to those who salary-reduced during the year in which a gain was generated and about whether former employees must be tracked down.
        • If a check, sent out to a former employee for a cash refund is returned, the IRS has no provision that the employer needs to track down the former employee. The DOL, on the other hand, may feel that the employer is required to do so.
        • Cash returned to employees from a health FSA gains is considered to be W2 wages for purposes of FICA and for federal income tax withholding.
      • Used to increase the annual coverage amount.
        • Cafeteria plan regulations do not state that gains can be used to increase the annual election, but an example in the regulations describes a scenario in which gains are used to reimburse claims incurred in the following year “above the elective limit.”
          • Must be made on a reasonable and uniform level. May not be allocated based on individual amount of forfeitures.
          • No limits are mentioned on the group of employees who are eligible for the increased coverage.
          • For participants who are already at or near the plan’s maximum annual coverage limit, an allocation of gains could place them over that limit. Accordingly, the plan document should specifically allow for this possibility in defining its maximum annual coverage limit
          • The limit of $2,650 (2018) on health FSA salary reductions does not restrict an allocation of gains (beyond $2,650) because no additional salary reductions are made to fund the additional benefit.
          • This option does have a potential of only recreating the problem in the next year. If the employees couldn’t use it all in the prior year, they also may not be able to use it in the current year.
    • To defray expenses to administer the cafeteria plan.
      • The plan document must state that the gains may be used to cover plan administrative expenses.
      • The expense must relate to health FSA administration and cannot be an initial expense of establishing the plan, or an expense related to another plan, such as dependent care.
      • The expense must be direct expenses properly and actually incurred in the performance of a fiduciary’s duties to the plan.
      • Payment of the expense must not be an ERISA prohibited transaction.
      • Paying for the TPA services of the health FSA is allowable, providing the costs are reasonable and are directly related to the health FSA.
      • Generally, most plan sponsors do not use this option if they are administering the health FSA in-house. Because the plan sponsor typically is a fiduciary, it cannot benefit from plan assets—being paid from plan assets may violate this prohibition.

Selecting the appropriate method for allocating experience gains depends on a variety of factors:

  • The amount of the gain
  • Whether the plan is administered in-house or through a TPA
  • Identifying the recipients
  • What the plan document provides
  • Timing of the allocation
    • After the run-out period: the gain could be allocated to defray reasonable administration expenses
    • Unless plan terms restrict timing, the gain can apply to the expenses of any plan year.

Satisfying the DOL requirement imposes a recordkeeping burden on the plan sponsor. At a minimum, the sponsor must maintain detailed records that show at least the following:

  • The nature of the expenses (clearly demonstrating that they relate directly to the health FSA)
  • The amount of the expenses
  • The dates on which they were incurred

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