Last month, Congressmen John Larson, D.Conn.,and Charles Boustany, R-La., introduced the Medical Flexible Spending Account Improvement Act (H.R. 1004), a bill that would end the unpopular flexible spending account (FSA) "use it or lose it" provision and instead allow FSA participants to withdraw and pay taxes on any remaining funds in their accounts at the end of the plan year.
An end to the forfeiture rule, from my perspective, would be a win-win for plan participants and employers alike. Let me tell you why.
It's no secret that "use it or lose it" is a big reason many employees pass on participating in their workplace FSAs each year. It seems like every time a personal finance reporter writes about the advantages of utilizing an FSA – saving up to 40 percent on your routine out-of-pocket health care expenses – it's followed by a large warning sign about how you must use it or lose it. What doesn't get reported is that the average plan participant spends all the money in their account by July – just seven months into the plan year.
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To address consumer fears, grace periods were introduced. It seemed like a good solution, but as out-of-pocket health care costs have continued to increase enrollment in FSAs has remained stagnant at about 20 percent.
Bottom line is that the potential to lose money was the most common reason employees decided not to participate in their workplace FSA, according to a 2010 survey by Schireson Associates.
And I get where consumers are coming from.
The challenge most participants face is that it's nearly impossible to pinpoint what their out-of-pocket health care costs will total a year in advance. Some people have regular prescription drug and medical expenses, but little else can be predicted — at least not with certainty. (As a side note, I always suggest prospective participants consider putting aside at least a small amount of money in an FSA that is below their actual out-of-pocket health care costs, since saving 40 percent off some of your routine costs is better than nothing. The annual contribution can always be adjusted over time.)
This brings me back to the legislative movement in D.C.
For consumers, a change to "use it or lose it" means that they will not be forced to use up or forfeit any remaining FSA funds simply because their family's needs didn't match their predicted annual health care expenses at the end of the plan year.
No more fear. No more confusion. If your predictions were off, you will not be penalized. How easy will that be to explain to current and prospective participants?
While a change to this policy will undoubtedly help plan participants, employers also stand to gain from the change because of one main reason – INCREASED ENROLLMENT.
Yes, I've heard about a couple employers worried about how to cover their administrative costs without forfeitures. However, it's important to remember that there are strict rules about how forfeitures can be used and the tax savings to employers from increased enrollment will be an automatic boon to the employer's bottom-line, far exceeding administrative costs.
It's FSA 101. More workplace participation in pre-tax benefits like FSAs will yield increased savings on FICA taxes (with incomes up to $106,800 subject to FICA, FSA contributions mean a 7.65 percent savings on every dollar contributed by employees making less than this amount).
For the policy wonks, there is also another reason why an end to the forfeiture rule is needed. The original purpose for the "use it or lose it" provision is now defunct. The rule was adopted to prevent FSAs from being misused as tax shelters; however, that concern no longer applies now that the health care law limits annual FSA contributions to $2,500 starting in 2013.
The bottom line is that ending "use it or lose it" will make FSAs a more attractive benefit for current/prospective plan participants and employers. As more individuals participate in workplace benefits like health care FSAs employers will receive the benefits of a healthier and more productive workforce and benefits providers will increase their customer base, making this proposal a win-win-win for all the parties involved.
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I'm planning to utilize this blog to answer questions submitted by readers about legislative and compliance issues impacting tax-advantage benefits. Please submit your questions to me at [email protected].
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