A flexible spending account (FSA) is a type of employer-sponsored health benefit that allows your employees to set aside pre-tax dollars for qualified medical expenses, such as deductibles, copayments, coinsurance, prescriptions, and more. An FSA can help your employees save money on taxes and health care costs, while also reducing your payroll taxes and enhancing your benefits package.
What is an FSA and how does it work?
An FSA is not an account that your employees own or access directly. Rather, it is a reimbursement arrangement between you and your employees. You decide how much money you want to allocate to each employee’s FSA per year, up to the IRS limit of $3,050 in 2022. You also decide what types of medical expenses are eligible for reimbursement under your FSA plan.
Your employees elect how much they want to contribute to their FSA during the open enrollment period, before the start of the plan year. They can only change their election amount during the year if they have a qualifying life event, such as marriage, divorce, birth, or adoption of a child.
You deduct the elected amount from your employees’ paychecks before taxes are calculated, and deposit it into a separate account that you manage. Your employees pay for their health care costs out of their own pocket or with their own insurance, and then submit proof of payment to you or a third-party administrator. You then reimburse them for the eligible expenses, either by check, direct deposit, or debit card.
The reimbursements are tax-free for your employees, as long as they have minimum essential coverage (MEC), such as an individual or group health plan. The contributions are also tax-free for both you and your employees, as they are not subject to income, Social Security, or Medicare taxes.
What are the benefits of offering an FSA?
Offering an FSA can have many advantages for both you and your employees, such as:
- Saving money on taxes: By allowing your employees to pay for their health care costs with pre-tax dollars, you can lower their taxable income and reduce their tax liability. This can also lower your payroll taxes, as the contributions are not subject to Social Security and Medicare taxes. You may also qualify for a tax credit of up to $500 per year for the first three years of starting an FSA plan, if you have fewer than 100 employees.
- Providing flexibility and choice: Your employees can decide how much they want to contribute to their FSA, up to the IRS limit. They can also choose how and when to use their FSA funds, as long as they are for qualified medical expenses. They can use them for a wide range of expenses, such as deductibles, copayments, coinsurance, prescriptions, dental and vision care, over-the-counter medicines with a prescription, medical equipment and supplies, and more.
- Enhancing your benefits package: By offering an FSA to your employees, you can provide a valuable health benefit that can help them save money and improve their well-being. You can also attract and retain talent, as many workers value this benefit highly.
What are the challenges of offering an FSA?
Offering an FSA can also have some drawbacks that you need to consider carefully, such as:
- Losing unused funds: Any unused balance in an FSA at the end of the year (or grace period) is forfeited by your employees. This is known as the “use it or lose it” rule. You can either keep these funds for yourself or use them to offset the administrative costs of the plan. However, this may discourage some employees from participating in the plan or cause them to overspend on unnecessary items.
- Following complex rules and regulations: You need to comply with various rules and regulations when offering an FSA plan. For example, you need to provide a written plan document that outlines the terms and conditions of the plan. You also need to substantiate the claims submitted by your employees and ensure that they are for eligible expenses. You may also need to file Form 5500 with the IRS if your plan covers more than 100 participants at the beginning of the year.
- Increasing administrative costs and responsibilities: You need to set up and maintain a separate account for each employee’s FSA funds. You also need to process the reimbursement requests from your employees and issue the payments in a timely manner. You may also need to provide education and communication materials to your employees about how to use their FSA funds effectively. These tasks may require additional time and resources from you or your staff.
How to start an FSA plan
If you are interested in offering an FSA plan to your employees, here are some steps you need to take:
- Choose an FSA provider: You need to find a financial institution or a third-party administrator that can help you set up and manage your FSA plan. You can compare different FSA providers based on their fees, features, services, and customer support.
- Design your FSA plan: You need to decide how much money you want to allocate to each employee’s FSA per year, up to the IRS limit. You also need to decide what types of medical expenses are eligible for reimbursement under your FSA plan. You may also want to consider offering some optional features, such as a grace period of up to 2 ½ extra months or a carryover of up to $610 per year for unused funds.
- Notify your employees about your FSA plan: You need to inform your employees about the availability and terms of your FSA plan at least 90 days before the start of the plan year or when they become eligible. You also need to provide them with enrollment forms and instructions on how to elect their contribution amount. You may also want to provide them with educational materials and tools on how to use their FSA funds wisely.
- Administer your FSA plan: You need to deduct the elected amount from your employees’ paychecks before taxes are calculated, and deposit it into a separate account that you manage. You also need to review and approve the reimbursement requests from your employees and issue the payments in a timely manner. You may also need to file Form 5500 with the IRS if your plan covers more than 100 participants at the beginning of the year.
Conclusion
An FSA is a type of employer-sponsored health benefit that allows your employees to set aside pre-tax dollars for qualified medical expenses. An FSA can help your employees save money on taxes and health care costs, while also reducing your payroll taxes and enhancing your benefits package. However, an FSA also comes with some challenges, such as losing unused funds, following complex rules and regulations, and increasing administrative costs and responsibilities. Before you decide to offer an FSA plan, you should consult with one of our benefit consultants to determine the best option for your business and your employees.