FSA rules, then and now
There is no legal limit on the amount of pretax dollars employees can put in FSAs. They can use that money to pay for qualified health care expenses, often using a debit card to access funds. Any money left in an FSA account at the end of the calendar year, or left behind when an employee changes jobs or is laid off, reverts to the employer, which typically uses the cash to offset the cost of employee benefits.

Employees must use all the money set aside in an FSA during the year or lose the unused portion. As part of the 2010 health care reform legislation, FSA rules are changing. Beginning in January 2011, employees must get a prescription from a doctor in order to use FSA funds to buy over-the-counter medication. Beginning in 2013, FSA contributions will have a $2,500 cap.

Finally, in 2018, FSAs will be subject to the so-called Cadillac excise tax, which will levy a 40 percent excise tax on health care benefit values that are above a stated limit. These changes are partly in response to suggestions that, in a rush to use up FSA money before the end of a calendar year, participants often purchased many products that they didn't need, essentially wasting a tax benefit. The bigger reason, however, is to increase tax revenue.

By making it harder to use pretax dollars on out-of-pocket health care expenses, legislators hope that consumers will spend already taxed dollars on the same expenses. According to projections from the Congressional Joint Committee on Taxation, the rule change regarding over-the-counter products will raise $5 billion over the next ten years.

Limits hurt participants — and TPAS
None of those changes specifically kills FSAs, points out Hilarie Aitken, a partner at Flex-Plan Services in Bellevue, Wash.,  a TPA for FSAs and other employee benefit programs. Even so, the changes make FSAs more difficult to use, and that will hurt employees, employers and the TPAs that run them. FSA proponents take issue with the idea that an FSA is a wasteful tax break.

“Detractors say there's an incentive for people to overuse their FSAs to buy stuff they don't need, and then get a tax break for that,” says Scott Mardis, senior vice president for sales at Ameriflex, a TPA in Mt. Laurel, N. J. “But that doesn't happen too many years in a row, because people adjust their spending levels to match reality.”

FSA opponents also point to seemingly limitless FSA contributions — which will disappear in 2013 — as another opportunity for wasteful tax breaks. Mardis, however, points out that even if consumers didn't put a practical cap on FSA contributions, employers would. “Most employers do set a limit to FSA contributions, because they don't want employees to access the whole amount and then quit,” Mardis says.

“In that case, the employer must make up the difference, and they move to limit their liability. They already police themselves and have a financial stake in doing so.” It's wasteful, however, to force consumers to get prescriptions for FSA-funded over-the-counter medications, Aitken says. “Doctors aren't wanting to give prescriptions for things like Claritin or Tylenol.

They don't want the liability of prescribing medications without a clear need or for patients they haven't seen for a particular issue.” Nor do doctors typically get paid for writing over-the-counter drug prescriptions. Some consumers might take the time to make a doctor's appointment to save a bit on cough syrup.

Those who do, Mardis says, could clog the calendars of general practice physicians, who already are in short supply in the United States. Moreover, those additional appointments and ensuing prescriptions have the potential to drive up the utilization of expensive health care.

“Take away FSA over-the–counter benefits and someone will go to the doctor and get a prescription, and that's penny wise but pound stupid,” Mardis says. “What was a $10 bottle of Advil, discounted down to $8, is now a doctor's visit plus a prescription.” Ultimately, Aiken thinks, fewer people will get prescriptions for over-the-counter medications.

“There always will be people who are willing to take the time to get the tax savings, particularly if they take a particular over-the-counter drug on a regular basis,” she says. “But most people won't bother getting the prescription. They'll just buy over-the-counter products out of after-tax dollars.” That's already happening in at least one pharmacy.

“There is definitely a difference in the number of people using FSA accounts for over-the-counter purchases, and I think a drop in the number of over-the-counter purchases overall. I feel it in my little store. I can only imagine what it's like in big stores,” says Dennis Galluzzo, a pharmacist at Family Medical Pharmacy in Buffalo, N.Y. Customers who do ask their physicians for a prescription for over-the-counter medication aren't getting enthusiastic responses, Galluzzo adds. “Some doctors are irate. They don't want to be bothered with it,” he says.

A dying benefit?
Aitken thinks the new requirement that consumers get a prescription in order to use FSAs to buy over-the-counter medication will reduce FSA participation — not just because getting a prescription is a hassle, but also because using a debit card to buy over-the-counter medications was probably the easiest way to use an FSA.

“Over-the-counter medication purchases are user friendly and easy, and they really served as a gateway to FSAs,” Aitken says. An employee who begins using a debit card — a familiar process — to buy an antihistamine is more likely to tackle the more complex paperwork necessary to be reimbursed for larger items than is someone who encounters potentially confusing, time-consuming paperwork on a first exposure to FSAs.

When fewer people want to participate in FSA programs, employers lose a valuable tool. Many employers are fighting the rising cost of health care insurance by implementing programs with higher co-pays and deductibles. An FSA, which lets workers pay those co-pays and deductibles with pre-tax dollars, is a logical benefit to put in place next to a high-deductible health insurance program—but only if employees are willing to use it.

“From an employer's perspective, an FSA fits into the larger scope of consumer-driven health care,” Mardis says. “If you're trying to implement a $2,000 deductible and you don't put an FSA in place, that money will come out of employees' pockets, money they may not have right now. An FSA could save them $1,200 a year in taxes, which significantly decreases the pain factor of that $2,000 deducible.”

Employers also save on payroll taxes for each employee who participates in an FSA. “Reduce those numbers and you reduce the employer's tax savings,” Mardis says. “The new cap gives employers one more reason to say 'forget it, it's not worth it.' The tax savings aren't as great and employees aren't as happy.” Given the relatively small size of the tax savings legislators hope will follow, Mardis says, “this takes away a benefit for very little return.”

Employers might have even less reason to offer FSAs beginning in 2018, when the Cadillac excise tax goes into effect. The new law will impose a 40 percent excise tax on any amount in excess of a stated limit on the value of health care benefits. “The 40 percent is assessed to the insurer, which in this case is the employer,” Aitken says. Money in FSAs counts as part of the overall value of each employee's health care coverage. If a plan's value is over the cap, Aitken says, “an FSA might be a place to trim.”

Taken together, the rule change — and the rule changes that will follow in 2013 and 2018 — might not bode well for TPAs. These administrators typically handle claims, accounting and compliance in return for a monthly per-participant fee. Fewer participants would mean less income immediately; a dwindling participant base could also mean that fewer employers offer FSAs in the future. Aitken asked the 54 people her firm employs if they thought the rule changes would lessen FSA participation.

“The consensus is that it could, and maybe would, deter participation,” she says. “A lot of people who aren't comfortable dealing with tax benefits will be less likely to use it, and it doesn't promote new users.” Mardis agrees, saying that he thinks overall FSA participation will go down. “This causes additional confusion and fewer people participating in an FSA program,” he says. Some statistics, however, seem to suggest that the 2011 and 2013 rule changes, at least, may not have a huge effect on FSA participation rates.

These numbers suggest that FSA participants, as a group, spend relatively little FSA money on over-the-counter medications, and much more on prescription drugs and medical treatments. Moreover, most FSA participants are already contributing amounts that are less than the upcoming FSA contribution limit of $2,500. By and large, this data seems to indicate, FSA participants are already working within the bounds of the first two FSA rule changes.

More will be revealed, of course, as time goes on. In the meanwhile, Aitken says, “It's important that participants and employers understand how these provisions are going to affect them. We need to keep on educating participants and reaching out to elected officials. As an industry we need to work on behalf of people who rely on FSA accounts to afford their health care.”