Five things you may not know about Health FSAs
A lot has changed in healthcare during the last four decades.
One constant, though, has been the Health FSA. It’s undergone some changes, but it remains an ally to families as they manage the ever-increasing cost of medical, dental, and vision care.
A Health FSA allows you to defer a portion of your income into a tax-free account to pay for qualified medical, dental, and vision expenses, as well as over-the-counter drugs, medicine, equipment, and supplies. You make an election in advance of the plan year and can change that election only with a status change (like birth, adoption, marriage, divorce, or death – not merely because you discover mid-year that you need more or less money in your account). You fund your Health FSA with level payroll deductions during the plan year. Many Health FSAs run on a calendar year, though employers can choose any 12-month period (for example, aligning the Health FSA with the medical-plan year).
You face a risk of forfeiting unused balances at the end of the plan year, though your company may have adopted an option (read more below) to give you additional time to spend your full election. But with a reasonable projection of qualified expenses, you can reduce your taxable income and enjoy the benefit of up-front cash to manage your out-of-pocket costs.
Here are five things you may not know about Health FSAs:
Participation Isn’t tied to enrollment in a medical plan
Employees who are eligible for benefits can usually enroll in the Health FSA. You’re not required to enroll in your company’s medical plan to participate in the Health FSA. You can, for example, be covered on a spouse’s or parent’s medical plan and elect to participate in your company’s Health FSA.
Also, family members don’t have to be enrolled in a participating employee’s medical plan to incur qualified expenses that you can reimburse from your Health FSA. Under federal tax law, qualified expenses can be incurred by
- Your spouse
- Your tax dependents
- Your children to age 26
This expansive list of enrolled family members can be a two-edged sword, though. Yes, more family members’ qualified expenses can be reimbursed tax-free. But if you have a general Health FSA, you may disqualify your spouse or adult child from opening and funding a Health Savings Account – even if your spouse or child never reimburses a qualified expense from your Health FSA.
Families can have two or more Health FSAs
A family isn’t limited to one Health FSA. In fact, neither is an employee. When a family with two working adults has high qualified expenses (think about vision-correction surgery, restorative dental services, or high-price prescription drugs), both spouses can participate in their employers’ Health FSAs (even if they work for the same company). They can each elect up to the maximum set by each employer (as much as $2,850 in 2022) – even if they both work for the same company.
Also, adult children under age 26 who remain covered on a parent’s medical plan but are eligible for benefits through their employer can enroll in a Health FSA through their company as well. When both a parent and a child are enrolled in a Health FSA, the child’s qualified expenses can be reimbursed from either account.
This double-Health FSA strategy can be especially effective when the spouses’ plans have different anniversary dates. A family can reproject spending during one Health FSA’s plan year before making an election to the other spouse’s plan that renews during the first Health FSA’s plan year.
Also, an employee who qualifies for benefits at two separate jobs can participate in each company’s Health FSA.
You can spend your election immediately
Experienced Health FSA participants are familiar with the concept of uniform coverage, even if they don’t recognize the term. Uniform coverage refers to the requirement that the full annual Health FSA election is available to participants on the first day of the plan year. This provision helps employees with cash flow when they incur high expenses early in the plan year.
The rate of spending doesn’t affect pre-tax payroll deductions. Thus, participating employees who spend their election faster than they fund the account through pre-tax payroll deductions essentially receive an interest-free loan from their employer. They add cash flow to tax savings on the list of benefits that they receive from a Health FSA.
Federal tax law prohibits your company from recovering any excess spending (above the payroll deductions received to date to fund the employee’s Health FSA) if you leave employment or lose eligibility to remain covered on the Health FSA (for example, you shift from full-time to part-time employment) during the plan year. Employers who offer a Health FSA accept the risk of absorbing the difference if your withdrawals exceed your payroll deductions if you terminate coverage during the year.
If you leave the plan during the year after spending less than what you contributed through payroll deductions (called underspending your account), you may be able to continue coverage by exercising your COBRA continuation rights. In that case, your spending limit would be equal to your payroll deductions – not your full (unfunded) annual election.
You may have more time to spend your election
Employers have the option to allow employees additional time – beyond the standard 12-month plan year – to spend their elections (though they’re not required to offer either). The two options are:
Carryover (also called rollover). Your company can permit you to carry over a portion of your unspent balance at the end of the year. Under federal tax law, the amount that you can carry over is limited to no more than 20% of the statutory maximum election. For Health FSA plans that start in 2022, the maximum carryover is $570 (20% of the maximum election of $2,850). Your company can set a lower carryover figure. Your employer can set restrictions (for example, you can roll over a balance only if you make an election for the following plan year), so be sure you understand how your plan works.
Grace period. Your employer can add an additional two months and 15 days to the plan year to give you additional time to spend that Health FSA plan year’s balances. For example, if you haven’t spent $1,500 of your election as of the end of your plan year on March 31, 2022, you can continue to reimburse qualified services that you receive through June 15, 2022 (provided your employer elects the grace period).
The grace period creates overlapping plan years if you participate in the following plan year’s Health FSA. This overlap helps you financially if you schedule multiple high-price qualified services that are most effectively provided at once (such as two dental implants or vision-correction surgery on both eyes simultaneously, as is standard). A single year’s election of $2,850 may not cover the full expense. If your plan includes a grace period, you can receive care during the grace period and apply elections from both plan years to reimburse the expense.
The bottom line
Not all employers sponsor a Health FSA, but larger companies typically offer the program. Most families – even those with low medical expenses – can benefit, as the range of qualified expenses includes most dental (like fillings, orthodontia, and restorative services) and vision (like glasses, contact lenses, and vision-correction surgery) purchases. The combination of tax savings and cash-flow benefits makes a Health FSA a benefit that you should consider during open enrollment.
William G. (Bill) Stuart is Manager, Planning and Business Analysis at Voya Financial. He has nearly three decades’ experience in employee benefits and had worked with Health Savings Accounts since their introduction in 2004. He chairs the American Bankers Association HSA Council’s compliance committee and is the author of HSAs: The Tax-Perfect Retirement Account.
The amount saved in taxes will vary depending on the amount set aside in the account, annual earnings, whether or not Social Security taxes are paid, the number of exemptions and deductions claimed, tax bracket and state and local tax regulations. Check with a tax advisor for information on whether your participation will affect tax savings. None of the information provided should be considered tax or legal advice.
This material is provided for general and educational purposes only; it is not intended to provide legal, tax or investment advice. All investments are subject to risk. Please consult an independent legal or financial advisor for specific advice about your individual situation.