What happens to FSA funds when an employee terminates?
September 8, 2021
There are only three types of expenses that a health Flexible Spending Account (FSA) can reimburse after an employee’s coverage terminates:
- claims for expenses incurred before the employee’s coverage terminates (e.g., on or before the employee’s employment termination date, if coverage ends on that date under the health FSA) that are presented before the end of the “run-out period”;
- if the participant elects COBRA, claims for expenses incurred during the COBRA coverage period and presented before the end of the run-out period for such claims; and
- claims incurred during a grace period provided under the plan, if the employee is entitled to submit such expenses.
Most health FSAs provide a period of time after the end of the plan year, known as the “run-out period,” during which claims incurred prior to the end of the plan year (or prior to the end of the grace period, if applicable) can be submitted. The run-out period simply provides additional time to submit already-incurred claims, and should be distinguished from allowing for reimbursement of claims incurred after coverage terminates.
Health FSAs are group health plans, thus subject to the federal COBRA. If the account is underspend, the individual would be offered opportunity to elect COBRA through the end of the current plan year.
How do we know if an account is underspent?
An employer determines whether a participant has overspent or underspent health FSA by evaluating the following:
- the participant’s maximum benefit for the plan year (e.g. employee and employer dollars);
- the amount of reimbursable claims submitted to the health FSA for the plan year before the qualifying event; and,
- the maximum amount that the employer is permitted to charge for COBRA coverage under the health FSA for the remainder of the plan year.
Any carryover amount is included in determining the amount of the benefit that a qualified beneficiary is entitled to receive during the remainder of the plan year in which a qualifying event occurs. If the participant’s maximum annual benefit minus the amount of submitted reimbursable claims is less than the maximum COBRA premium that can be charged for the rest of the year, then the health FSA is “overspent.” If, however the remaining annual benefit is more than the maximum COBRA premium that can be charged for the rest of the year, then the health FSA is underspent.
“Overspent” means that the remaining HFSA benefit (i.e., annual election amount minus claims already reimbursed) is less than or equal to the COBRA premiums that would be required for the rest of the plan year.
For instance, assume the employee had elected $1,200 for a calendar-year health FSA, made $1,000 in eligible claim reimbursements, and then terminated employment on June 30. The health FSA was overspent since the remaining annual limit of $200 is less than the amount of COBRA premiums ($600) that would be due for July through December. In that case, the employer is not required to offer COBRA. (Note that the 2 percent administrative charge for COBRA is disregarded in our example.)
Due to claim lag, it can be difficult to determine whether a particular employee’s health FSA is overspent upon termination. For this reason, some employers prefer not to apply the overspent rule and instead offer COBRA to all health FSA participants.
We do encourage further review on this topic with your health FSA vendor, who can likely offer assistance in determination if an account is under or overspent.
For more information, please see: Health FSAs, carryover provision: Questions 21 through 25 in IRS Notice 2015-87: click here.
Did you know? The CIP Group helps administer FSA, DCA, HRA and HSA Accounts! Contact your account manager, or submit a request online for more information.