What Happens to That “Use It or Lose It” FSA Money?

Offering any type of healthcare plan to your employees is beneficial to both of you, and not just because they help keep your employees healthy and productive. There are a lot of tax benefits to offering healthcare, especially if you include savings accounts like flexible spending accounts (FSAs). 

FSAs, which you can offer alongside any type of healthcare plan (employees don’t even need to participate in the plan to opt into the FSA), allow employees to put money aside on a pre-tax basis and then use it for qualified medical expenses. This reduces your employees’ taxable incomes, as well as your payroll taxes. The downside for employees? The money in these accounts doesn’t roll over each year, so if they don’t use (most of) it, they lose it. The good news? That money reverts back to you, and you have a few options of what to do with it.

dollar bills in the ground growing
Employees can then use the pre-tax money throughout the year on a wide variety of expenses,

How FSAs Work

If employees choose to opt into your offered FSA, then they will contribute a certain amount of their paycheck to the account. They can then use that pre-tax money throughout the year on a wide variety of expenses, such as deductibles, copays, coinsurance, glasses, dental care, prescription and OTC medications, and even many common drugstore items. Employees’ annual contributions are taken out of their paychecks in installments, and they are treated as salary reductions for tax purposes (hence the tax benefits!). The reimbursements for the qualified expenses are also tax-free. 

Both you and your employee can contribute to their FSA, but your employee’s contribution cannot exceed a certain amount. For 2020, that amount is $2,750. Whatever you choose to contribute is in addition to that amount and does not count towards their limit. 

The “Use It or Lose it Rule”

FSAs take a bit of planning on an employee’s part. They need to choose their contribution amount during an annual enrollment period, and that amount cannot be changed during the year unless certain qualifying “change of status” events occur, such as change in marital status. 2020, however, has been a bit different: the IRS announced in May of this year that they will allow mid-year changes to FSA contributions, but this is most likely a temporary measure. 

money rolled up in a rubber band on a white table.
With an FSA money not used by employees doesn’t go to waste! A portion can roll over!

If employees don’t end up using all of the money in their FSA accounts by the end of the year, then the balance generally reverts back to you, the employer. There are two exceptions to this “use it or lose it” rule:

  • Your FSA can allow a 2 ½ month grace period, meaning that (if your FSA operates on a calendar year basis, which most do) your employees will have until March 15th to use the funds
  • Your FSA can allow employees to roll over $500 of their unused balance into the next year

You can only offer one of these options to employees, and you are not actually required to offer either of them, but it is common practice to do so. If you do offer one of these options to your employees, and they still have more than $500 left in their account at the end of their year, or if they haven’t used up all of the money by March 15th, then that money reverts back to you. So what do you do with it?

What You Can Do with Forfeited Money

The IRS gives you a few options of what to with any unused FSA dollars. You can use it to:

  • Help with plan administration costs. You can choose to outsource the administration of your FSA for a cost of around $5/month/employee, and you can use the leftover funds to pay for it. 
  • Reduce employee FSA salary reductions for the next year. For example, if an employee wants to contribute $500 to their next year’s FSA, you could allow them to contribute only $480 and use leftover funds to make up the other $20. caucasian hand putting coins into a black piggy bank.
  • Add money to employees’ accounts. You can choose to use the money to offset any extra expenses incurred by employees in the next year. For example, if an employee contributes $1,000 to their next year’s FSA, but submits claims for $1,200, you can use leftover FSA money to cover that extra $200. This is generally not the most popular option, because it is only useful to employees if they spend more than they’ve put aside. They might also begin to expect this extra coverage every year. 
  • Pay your employees in cash. If you choose to do this, you need to make sure that you are distributing the money in a “uniform” fashion, meaning you can’t just give the money back to the one or two employees who didn’t use their FSA money. You would also need to track down any former employees from that year and pay them their share. Remember, too, that the money you give them will be considered income, so it must be reported and will have taxes deducted from it. 

Tax-advantaged healthcare benefits are basically a win for everyone involved, even with the small caveat of the FSA “use it or lose it” rule. You and your employees save on taxes, and any balance remaining in their account is never truly “lost” – you can take it and use it to continue helping them (or your business) with healthcare costs. We get it, this is all complicated stuff, so if you have questions about offering FSAs or any other type of group health benefit, we can help. Drop us a line and we’ll set you up with one (and only one) knowledgeable agent who will answer all of your questions, go over all of your options with you, and give you fast, accurate quotes when you’re ready for them. Ready to get started? Simply enter your zip code in the bar above, or to speak to an agent, call 888-998-2027.

Speak with an agent today!
Get Quotes