A flexible spending account (FSA) is a type of benefit that can be offered by an employer as a way for employees to save for medical & dependent/childcare expenses with pre-tax dollars. As an employer benefit, it can be offered in lieu of health insurance or in addition to it. An FSA is a “use it or lose it” account that is meant to be used before a set time period ends, usually 1 year. It is also known as a Flexible Spending Arrangement and is usually a part of a cafeteria plan.
In this article, we will explain:
- What Is a Flexible Spending Account
- How a Flexible Spending Account Works
- When Should I Offer a Flexible Spending Account
- The Benefits of a Flexible Spending Account
- The Drawbacks to Flexible Spending Accounts
- How to Offer a Flexible Spending Account
What Is a Flexible Spending Account
In plain words, an FSA is an account where an employee can set aside a set amount of money each month, pre-tax, and the money in it can be used for medical or childcare/dependent care expenses. In fancy terms, an FSA is a form of health reimbursement benefit, funded by employee-decided contributions with pre-tax dollars, that reimburses employees for expenses incurred for certain qualified benefits.
An FSA may be offered for dependent care assistance, adoption assistance, and medical care reimbursements (such as copays, prescription expenses, or even medical costs like buying eyeglasses). The benefits are subject to an annual maximum set by the government and are subject to an annual “use-or-lose” rule.
Employees with FSAs need to be reminded toward the year-end of the plan to make the most of their dollars saved. According to SHRM, the FSA limit for 2017 rose to $2,600, and they predict that the amount allowed will go up as our healthcare market continues to change each year. The dependent care FSA, aka DCAP, has a different limit of $5,000 per year.
Flexible Spending Accounts (FSAs) are comprised of two separate kinds of accounts:
- A Health Care Reimbursement Account (HCA)– This is an FSA primarily used to pay medical only expenses like co-pays or prescriptions. These can also be used towards medical premiums.
- A Dependent Care Assistance Account (DCA or DCAP)– This is an FSA primarily used to pay for any form of dependent care. Dependents count as children under 13, disabled or seriously ill children of any age, disabled or ill parental care, or even care for a disabled or ill spouse. They can help pay for the medical expenses or the caretaking (i.e. nursing home expenses).
These two accounts provide employers and participants an opportunity to reduce their tax liability on money spent toward health care expenses and/or dependent daycare expenses.
How a Flexible Spending Account Works
Understanding how an FSA works is 90% of the battle for you as the employer and for your employees.
Rules around FSAs
The major rules are an FSA are as follows:
1. No rollover- Use It or Lose It
The major rule behind an FSA that makes it different from an HSA (health savings account) is that you need to use it or lose it during the plan year. If you don’t spend your money, the leftover amount in the FSA actually goes back to your employer (although some plans allows for up to $500 to be carried over).
2. Contribution limits
For 2017, the IRS has put a limit of $2,600 on the amount that can be put into an FSA pre-tax (either by the employee alone or with the employer’s help). Once that limit is hit, you can still contribute, but the money will be taxed as normal.
An FSA is owned and run by an employer; there is no option to get one on your own in the marketplace, unlike an HSA. If your employees leave their job for any reason, the FSA balance will go back to you as the employer and they will lose their contributions.
4. Employers can contribute
Employers can decide to match employee contributions in the medical FSA. The employer may contribute: No more than a one-to-one match of the employee’s contribution, or if the employer’s contribution would exceed a one-to-one match, then the employer contribution can be no more than $500.
So when does offering an FSA make sense as a business owner?
When Should I Offer a Flexible Spending Account
You are probably starting to wonder if offering an FSA is a good idea for your small business. We’ve narrowed it down to about 3 scenarios to help you to work out if it makes sense for you and your business.
Scenario 1: You want to offer an additional benefit on top of your insurance.
If you are a small business owner who already provides help insurance, you might want to offer an FSA pay out-of-pocket expenses on top of their normal health insurance, or offer an FSA that is geared towards child/dependent care. It can be a nice value-add to tack onto your already-running insurance plan at little expense to you as the business owner.
Scenario 2: You’re a small employer that doesn’t offer health insurance. You want to provide a benefit that won’t cost you too much to administer.
If you have less than 50 employees, you don’t need to provide health insurance by law. If you don’t provide health insurance at all, an FSA is a great way to keep your employees happy and help them to afford their healthcare in the marketplace. You even get to keep the money they don’t spend either at the year end or if they leave your business, so you really have nothing to lose between this and the tax savings an FSA can offer you!
Scenario 3: You’re a small employer with mostly young/single employees and looking for a benefit to provide.
If all of your employees are young, you might not need to provide health insurance since it’s not important to them. However, an FSA may not be a good idea either since employees might not use it in the correct way if they are still on their parents’ insurance and they cannot take it with them. We would urge you to consider going with a retirement plan benefit instead, like a 401K, to really add value to a young employee’s financial future.
Top 3 Benefits of a Flexible Spending Account
Here are the top 3 benefits that an FSA can offer you as the employer:
1. The FSA is an easy to understand benefit
Once someone is registered and contributing to an FSA, it is easy to understand because your employees will most likely get a debit card sponsored by the FSA. If they use that debit card, the money then comes out of the FSA account once it is approved. Simple- just like a checking account. This will save you as the business owner headaches in explaining it over and over.
2. Easy to plan for
Your employees decide how much they want to contribute- you just have to enter it correctly into the payroll software to do so. The contribution amount is fixed the entire year, so that means only 1 time of changing anything in your payroll software per year.
3. Wide variety of uses
Your employees will be thrilled that they can use their FSA on any approved medical expenses. This could mean their child’s dentist exam, contacts for themselves, or prescriptions… anything really that qualifies. Depending on the kind of FSA you have, employees can even pay for insurance premiums through them; if you want a Premium Only Plan (POP), we will direct you to our section 125 article for more information. Happy employees make for a happy business owner.
Top 3 Drawbacks of an FSA
No employee benefit is perfect and an FSA is no different. The top 3 cons to an FSA are:
1. Use it or lose it
Employees can get frustrated with the fact that they have to use their contributions before the year is over, or they will lose their dollar amount. Some providers allow you to set a small carryover amount like $500; however, you will need to remind them to use their dollars repeatedly.
On the other hand, as the business owner, you get to keep whatever is leftover in their FSAs… but, not so fast, it has to go towards the administration of the FSA, not just into your shopping fund. However, this can still be a major perk. It can make the FSA administration net zero, or you can use the funds to up your contributions to your employees, giving them a tax-free raise.
2. Cannot change contribution amounts
Once an employee sets an amount for the year, it’s done. So if Joey falls on hard times, he cannot change it, which may cause some bitter sentiment from employees to you as the business owner. Make sure employees are crystal clear on the rules of an FSA.
3. Cannot “take it with you”
If you fire Joey or if Joey quits, his FSA is over and he cannot take it with him. Unlike an HSA, which the employee owns, the FSA is owned by the employer. While not a problem for you as the business owner, make sure your employees understand this.
How to Offer a Flexible Spending Account
Similar to other employee benefits, you will want to work with one of the following types of benefit providers:
- An online employee benefit provider, like Gusto.
- A Professional Employer Organization (PEO), like Justworks.
- A private insurance broker.
- Going directly to a large insurance company, like Aetna or Blue Cross.
Since getting a quote and comparing providers is free, it can’t hurt you to look at all 4 kinds of providers and perhaps you can even solve a second issue like payroll at the same time. Regardless, you will want to work with a certified benefits company or professional in order to make sure that you offer an FSA in the right way, and then they can also help you to explain it to your employees and get them registered.
The Bottom Line
An FSA can be a great value-add benefit for your employees in order to help with their healthcare costs or childcare costs. Once employees understand how to use their FSA, they can be a win all around for employees and employers in reducing healthcare costs and tax liabilities.