by Matt Gerard
on November 8, 2019
Beginning January 1, 2020, California employers may face additional notice requirements when offering a flexible spending account to employees. Recently California’s Governor signed into law, Assembly Bill No. 1554, which requires employers to notify employees who participate in flexible spending accounts of “any deadline to withdraw funds before the end of the plan year.” The law applies to health care flexible spending accounts (FSAs), dependent care FSAs (DCAPs), and adoption assistance FSAs. Employers must notify their employees via two different methods, but only one of the methods may be electronic (for example, in-person and text message). The new law does not stipulate when employers must make such notifications or the penalty for failing to notify employees. Further, the statute does not provide a model notification form or mandatory notice language.
This lack of specificity is odd, considering the purported purpose of the bill according to the legislative history. First, the bill’s author expressed an interest in ensuring employees have additional opportunities to use their FSA funds and avoid the “use it or lose it” risk of FSAs. Later, the Senate Committee on Labor, Public Employment and Retirement surmised that employers were more incentivized by the ability to use forfeited FSA funds to offset plan administration costs then by reminding employees to fully utilize their available funds. Perhaps the California law attempts to provide notification for employees who lose coverage due to a mid-year termination; however, the law does not state that employers must provide notification at a specific time, such as an employee’s date of termination. Because of the three-sentence-long statute’s lack of clarity, California employers, through their current plan design and practices, may already be complying with this new law.
Whether the Law Applies to Heath FSAs
Unless an exception applies, health FSAs are employee welfare benefit plans subject to the Employee Retirement Income Security Act of 1974 (ERISA). ERISA contains a broad preemption provision that preempts, or blocks from enforcement, any state law that “relates to” ERISA. Consequently, ERISA would likely preempt the California state law because it impacts ERISA plan administration. Nevertheless, ERISA does not apply to health FSAs sponsored by church organizations or most governmental authorities. Thus, private employers who only sponsor a health FSA will likely not be required to comply with the California statute. Until a court holds that ERISA does preempt the California statute, California employers who sponsor a health FSA, whether subject to ERISA or not, should comply with the new notification requirement.
Nevertheless, cafeteria plan design may circumvent the California law altogether. As previously stated, the California law requires that employers notify employees of “any deadline to withdraw funds before the end of the plan year.” However, employers may include a grace period provision in their cafeteria plan document. IRS guidance provides for a grace period that allows participants to access unused benefit amounts to pay or reimburse expenses for qualified benefits, such as health FSA expenses, incurred up to two and a half months after the close of the cafeteria plan year. The effect of the grace period is that employees may have 14 months and 15 days (12 months in the cafeteria plan year plus 2½ months for the grace period) to use benefits or contributions for a plan year before forfeiting those amounts under the use-or-lose rule. Consequently, a cafeteria plan with a grace period would not require participants to withdraw their funds before the end of the plan year and, hence, likely rend the California law inapplicable.
Note to employers: Offering a grace period is optional and employers who wish to offer grace period must so specifically provide in their cafeteria plan document. Employers should also be aware that offering a grace period can raise compliance and administrative issues—such as precluding participants’ from carrying over unused health FSA funds to the subsequent plan year, precluding participants’ eligibility for health saving account (HSA) contributions, and application of certain COBRA requirements. IRS guidance addresses some of these concerns; however, employers who wish to offer a grace period should consult with qualified professionals in the legal, tax, or employee benefits industry to learn how a grace period may affect the employer’s cafeteria plan and the participants thereof.
Additionally, many health FSAs provide a period after the end of the plan year (or grace period), known as the run-out period, during which participants may submit claims incurred before the end of the plan year or applicable grace period for reimbursement. The run-out period does not allow for reimbursement of claims incurred after coverage terminates; the run-out merely provides more time for participants to submit previously-incurred claims. Employees who terminate mid-year may still file eligible claims (those incurred before termination of coverage) during the run-out period.
Employers who offer a “run-out period” for health FSA benefits may have to comply with the California law. For example, if an employee terminates on July 31, the former participant would have until the end of the run-out period (say 60 days after the end of the plan year) to submit health FSA claims incurred on or before July 31. However, in this case, the California law may not apply because the terminated employee would not be required to withdraw funds before the end of the plan year. Conversely, many health FSAs provide a shortened run-out period for employees who terminate mid-year (such as 60 days after the date of termination). Because of this shortened run-out period, employees may be required to withdraw funds before the end of the plan year depending on their termination date. Consequently, such a plan would feature a deadline before the end of the plan year by which employees would need to withdraw funds; hence, the California law would apply. These run-out period examples highlight and exploit ambiguity within the California statute’s language. Employers have the responsibility to consult their legal advisors to determine the best interpretation of the statute and how employers will comply.
Whether the Law Applies to DCAPs
The California statue will be governing law for DCAPs because, except in rare circumstances, DCAPs are not ERISA welfare plans, so ERISA’s preemption provision will not apply. The California law requires that employers notify employees of “any deadline to withdraw funds before the end of the plan year.” Nevertheless, with proper plan design, the new law will not apply to an employer’s DCAP because employers can design cafeteria plans which permit participants to exhaust remaining DCAP funds either at or after the end of the plan year.
As discussed above in the health FSA section, IRS guidance provides for a grace period that allows participants to access unused benefit amounts to pay or reimburse expenses for qualified benefits, such as DCAP expenses, incurred up to two and a half months after the close of the cafeteria plan year. Again, a cafeteria plan with a grace period would not require participants to withdraw their funds before the end of the plan year and, thus, likely rend the California law inapplicable. Be aware that an employer may adopt a grace period for certain benefits under its cafeteria plan. For example, employers who sponsor both a health FSA and a DCAP can limit the grace period to the DCAP and offer a carryover under the health FSA. However, see note to employers.
Instead of, or in addition to, offering a grace period, a cafeteria plan may provide a spend-down provision. Under IRS regulations, a spend-down provision allows employees whose participation has ended (e.g., due to termination of employment) to be reimbursed from their remaining DCAP account balances for eligible post-termination expenses incurred during the remainder of the plan year (and during any grace period immediately following that plan year). With a spend-down provision, employees—including terminated employees—would not be required to withdraw DCAPs funds before the end of the plan. Hence, the California law would likely be inapplicable to cafeteria plans with a DCAP spend-down provision. Like the grace period, a spend-down provision is optional, and employers who want to feature such a provision must so expressly state in their cafeteria plan documents.
Whether the Law Applies to Adoption Assistance FSAs
Like DCAPs, adoption assistance FSAs are likely not subject to ERISA. Thus, the California law will likely be governing law for adoption assistance FSAs. However, like health FSAs and DCAPs, adoption assistance FSAs may also benefit from a cafeteria plan’s grace period. As previously mentioned in the previous two sections, including a grace period in the cafeteria plan will likely make the California law moot. However, see note to employers.
Existing Disclosure Requirements for Plans
Both ERISA and the Internal Revenue Code obligate employers who offer health FSAs, DCAPs, and adoption-assistance FSAs to notify participants of certain information. ERISA requires plan administrators to provide a Summary Plan Description (SPD) to each participant within ninety days of the individual becomes covered by the plan. Many employers provide the SPD to all eligible employees in advance so the employees can make informed decisions about whether to enroll in the plan. Additionally, ERISA requires plan administrators to provide an updated SPD every five years. Generally, the SPD must inform participants of their rights and obligations as well as the plan’s specific terms, conditions, limits, exceptions, and restrictions in easily understandable language. ERISA also requires plan administrators to provide a Summary of Material Modifications (SMM) within 201 days after the end of a plan year in which the plan sponsor made material modification to the plan’s terms or in which the plan sponsor adopted required changes to the SPD information. Again, many employers notify participants of changes to the plan well before implementing such changes so that employees may make informed decisions regarding their benefits.
The content requirements of the SPD are beyond the scope of this article. Nevertheless, a properly drafted SPD will likely inform participants of critical deadlines, such as the date the plan year ends as well as applicable deadlines by which participants must incur and submit claims. Certainly, health FSAs which are subject to ERISA should (and must) provide a SPD and SMM to participants. Additionally, participants have right to receive the latest SPD and interim SMMs within thirty days of making a request for such documents. While health FSAs not governed by ERISA are not required to make such disclosures, best practices for employers include providing information similar to that required by ERISA to employees regarding the health FSA benefit.
As previously stated, DCAPs and adoption assistance FSAs are not typically ERISA plans, so ERISA disclosure requirements, such as the SPD and SMM, would not apply to these benefits. Nevertheless, the Internal Revenue requires a plan sponsors of DCAPs and adoption assistance FSAs to provide eligible employees with “reasonable notification of the availability and terms of the program.” Employers following best practices will provide relatively detailed information to their employees regarding the material provisions of the program, a description of how the program operates, the interaction of the plan with applicable tax credits, and certainly the use-or-lose nature of the funds as well as applicable deadlines to incur and submit claims.
Bottom Line on Compliance
Setting aside preemption issues, the California statute is governing law in California for employers who offer a health FSA, DCAP, or adoption assistance FSA. The law is not onerous, and it conforms with best practices anyway. Employers who offer their employees benefits must disclose certain information to participants. In addition to those notifications required by ERISA or the Internal Revenue Code, best practices for administering an FSA of any type include providing additional periodic disclosures and information to participants such as: periodic account balance information, year-end and run-out period reminders with current account balances, and enrollment materials that contain plan deadlines. If employers review their current notification procedures, employers will likely discover that they are probably already complying with the statute. Employers who utilize a third party administrator (TPA) should clearly establish who is responsible for plan disclosures, the form and content of plan disclosures, and the timeline for plan disclosures. If between the required and optional disclosures an employer is not in compliance with the California law, then employers can change the plan design to render compliance moot or revise the content and timing of notifications to employees. Simple changes to comply with a simple law.
Disclaimer: This article is for informative and educational purposes only. Nothing in this article constitutes, nor is intended by the author to serve as, legal advice. Individuals should consult their own legal advisors on compliance with governing federal or state law. Employers who offer employee benefit plans should consult their own legal and tax advisors on compliance with applicable governing laws and regulations.
