Following up on changes to flexible spending accounts (FSAs) implemented by the December 2020 budget bill (the Consolidated Appropriations Act, 2021), the IRS provided interpretative guidance of its own in Notice 2021-15.
As we reported previously, the budget bill provided several new and rather generous rules for both health care and dependent care FSAs, such as the ability to carryover all unused amounts from 2020 into 2021, the ability to carryover all unused amounts from 2021 into 2022, the ability to apply a grace period for up to a full 12 months (rather than the usual 2½ months), and the ability to permit employees to make prospective election changes.
The new IRS guidance follows up on these rules with several clarifications and additions, and there are many items for employers to think about when deciding what changes to implement. The below-discussed changes are not required, and employers have a lot of flexibility in deciding how to implement any desired changes.
Some notable items for employers to consider include:
If I Allow a Rollover or Grace Period, then how do I Also Help Employees Preserve their HSA Eligibility?
- Background. In a nutshell, in order to be eligible to establish or contribute to a health savings account (HSA), which is a savings account that can be used to pay for qualified medical expenses using pre-tax dollars, the employee cannot be covered under any health plan other than a high-deductible health plan. And unfortunately a carryover or grace period from a general purpose FSA constitutes disqualifying coverage for HSA purposes during the grace period or carryover window. While this problematic issue already existed before the law changed, it may affect more employees now that carryovers and grace periods can extend through 2022.
- What to Think About. Several options exist to fix the problem above, such as:
- Allowing employees to waive carryover balances, which means the employee will forfeit funds, but the tax benefits of an HSA may greatly outweigh that loss;
- Automatically converting any leftover amounts from general purpose to limited purpose FSAs (the latter generally covers only dental and vision benefits); or
- Limiting the carryover or grace period to fewer than 12 months, which means an employee won’t be HSA eligible during months when the carryover or grace period remains effective, but potentially could contribute the full amount to their HSA if they’re eligible on December 1 of that year as long as they remain an HSA-eligible individual for the entire next year (i.e., covered by a HDHP and without any other disqualifying health plan coverage).
What Kind of Prospective Changes Am I Allowed to Offer My Employees?
- Background. Outside of the latitude initially provided during 2020 due to COVID-19 and now provided through 2021, employees could generally only make changes to FSA and health plan elections under the employer’s cafeteria plan in accordance with HIPAA special enrollment rules or due to certain mid-year status changes (such as birth, marriage, employment status, etc.). Through 2021, however, plans may generally allow prospective changes under any of the following circumstances for any reason:
- Make new elections, revoke prior elections, or increase or decrease an existing election for health care or dependent care FSAs;
- Make new elections for employer-sponsored health coverage, even if the employee initially declined that coverage;
- Change coverage options under the employer’s health plan, such as moving from self-only to family coverage; and
- Revoke an existing election for employer-sponsored health coverage, as long as the employee attests in writing that they have or will be immediately enrolled in other health coverage, such as a spouse’s employer plan, Medicare, or the Marketplace.
- What to Think About. In addition to preserving HSA eligibility noted above, decide:
- Do you want to limit the carryover to an amount less than all unused amounts? Remember that these special rules expire next year, so employees who carry a large balance into the end of next year may face the possibility of losing thousands of dollars.
- Outside of status changes, do you want to limit the number of times when someone can make an election? Do you want to restrict the circumstances under which someone can make a change; for example, limit to changes that only increase coverage (e.g., moving from self-only to family coverage)? When making these design choices, weigh employee freedom against administrative complication and potential expense (e.g., employees adding/increasing coverage upon receipt of an expensive diagnosis).
What Else Should Employers Do?
- Remember to Amend Your Cafeteria Plan—The Sooner, The Better. In general, you shouldn’t be adopting retroactive amendments to your cafeteria plan; instead, you should adopt amendments prior to their effective date. The change discussed above, however, as well as certain others available due to COVID-19, may be made as late as the end of the plan year after the change is effective. That said, we recommend amending your cafeteria plan as soon as possible so that you document your operational intentions and so that the amendment doesn’t slip through the cracks.
- Reach out to Your Administrator—The Sooner, The Better. Assuming a third-party administers your FSAs and/or health plan enrollments, reach out to them to determine what options they’re able to administer and how such options will be communicated to enrollees. Make sure to stay in contact with them and keep them apprised of what you want to do and to hear what suggestions they might have.
- Don’t Forget About COBRA. An employer that decides to allow extended post-employment termination reimbursements from a health FSA still has to provide a COBRA notice. In other words, just because the plan will reimburse for expenses incurred after the termination does not mean that the termination is not a qualifying event for COBRA. And if an employer adopts an increased carryover or extended grace period, the employer cannot charge a COBRA premium in order to access leftover amounts after the end of the plan year that would otherwise be accessible.