By: HUB’s EB Compliance Team

Because of the health flexible spending arrangement (“FSA”) “use it or lose it” rule, there are usually a few employees that have money left over after the end of the year. The first step is to use these to offset any amounts paid to employees who spent more than their contributions during the year. Any amounts left over after that are sometimes called “experience gains.” An employer might be tempted to think that this is free money, but wait! There are limits to what employers can do with these funds.

Of course, the employer should wait until the end of any run-out period to use the money. Employees may have incurred expenses, but not submitted them for reimbursement yet. Most plans have a set period (such as March 31 of the following year, for a calendar year plan) to submit expenses for the prior year.  

If any money is left over after that period, the employer has four options. The employer can use one or more of these options until all the leftover health FSA funds are spent. However, as an initial matter, the employer should make sure that its plan document permits any or all of these options for leftover health FSA funds. Employers using a third-party administrator (“TPA”) to administer the health FSA should also make sure the option they choose can be handled by the TPA.

Option 1: Reduce Administrative Expenses

Employers can take the money and use it to pay the health FSA administrator. Most employers use a TPA to run the health FSA. The leftover funds could be used to pay that TPA, for example.

Note that most health FSAs are subject to a federal law known as ERISA (the Employee Retirement Income Security Act). ERISA requires that these leftover funds be used for the benefit of the health FSA plan and no other plan and not for the benefit of the employer. Therefore, in paying administrative expenses, be sure the expenses are specific to the health FSA plan and not used to benefit participants of another plan.  

If an employer uses health FSA funds to pay for another plan or keeps the money itself, that is a prohibited transaction under ERISA. The employer could be penalized with excise taxes and civil monetary penalties for misusing those funds.

This is by far the most popular approach because it (indirectly) lowers the employer’s cost for administering the plan. It also does not require any special communications to employees, beyond the standard summary plan description.

Option 2: Reduce Salary Contributions for Next Year

Another option is to give employees a “contribution holiday.”  In other words, the leftover money from a year (e.g., 2020) is used to reduce the employees’ contributions in the following year (e.g. 2021).  This comes with a few requirements:

  • The money can be allocated per person (e.g. $30 holiday per person) or weighted based on employee elections in the plan (e.g., someone who elected $500 gets a $10 holiday, someone who elected $1,000 gets $20, and so on).
  • The money cannot be allocated based on reimbursements made. In other words, employers cannot return money based on how employees spent (or are spending) their health FSA funds.

It is unclear whether the employees receiving the holiday had to be participating in the prior year. In other words, can leftover funds from 2019 be used for a holiday for all participating employees in 2020 or only those who were in the health FSA in 2019? It is more conservative to allocate it only to those who participated in 2019.

The positive here is that employees tend to like this since it increases their take home pay. However, it does have to be communicated to employees. Additionally, if the employer takes the more conservative approach to offering the contribution holiday, some employees who didn’t participate in the prior year may feel unfairly slighted. Good communication is key.

Option 3: Increase Reimbursements

The third option is to increase the maximum reimbursement for employees in a later year. In other words, all employees get a little extra money over and above what they elected for a later year. The same allocation rules as Option 2 apply. In other words, the increase can be applied per person or per elected amount, but not in proportion to reimbursements made. This option, like Option 2, raises the same question about whether all employees in the plan can receive it or only those who participated in the year the leftovers happened. However, on the plus side, it appears that these additional amounts can be allocated to employees who elected the maximum amount for a year.

Many employers do not favor this option. First, many employees made elections without assuming these increases. Therefore, they may not be able to use the funds. If so, then these will just become leftover funds for this new year. Like Option 2, this would also need to be communicated. Finally, this option may also be difficult for the TPA to administer.

Option 4: Cash Refunds

As a last resort (typically), employers can issue cash refunds. As with Options 2 and 3, the refunds can be per person or in proportion to elections; they cannot be in proportion to expenses reimbursed. Additionally, here there is a stronger argument that those who contributed to the leftovers should receive the refund. If that’s the case, that may involve chasing down former employees who participated in the health FSA. Finally, these cash refunds are taxable, so withholding taxes apply.

Not an Option: Paying Corporate Expenses

As noted above in Option 1, the health FSA leftover funds can be used for administrative expenses for that health FSA plan, but not anything else. Taking the money back into corporate assets is a prohibited transaction under ERISA which can lead to fines and penalties. The leftover funds must be used for the benefit of participants specifically in the health FSA plan.

If you have any questions, please contact your HUB Advisor. View more compliance articles in our Compliance Directory.



The information herein is intended to be educational only and is based on information that is generally available. HUB International makes no representation or warranty as to its accuracy and is not obligated to update the information should it change in the future. The information is not intended to be legal or tax advice. Consult your attorney and/or professional advisor as to your organization’s specific circumstances and legal, tax or other requirements.