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Spend down for Health FSAs


smm

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The proposed 125 regulations specifically allow a spend-down for a DCAP. The regulations appear to be silent on whether a spend-down is permitted for a health FSA. (correct me if I am wrong) I am aware of plans that have spend-downs for both DCAP and Health FSAs. Are they permitted for Health FSAs? If so, are they limited to the amount contributed as of the date participantion ceases or does the normal universal coverage rule apply.

BTW - by spend down, I am referring to claims incurred after terminatin of participation but during the period of coverage.

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The 2007 regs specifically allow for DCAP spend down, which is that the former employee can tap the unused balance for reimbursement of qualifying day care expenses incurred during the remainder of the plan year (and if the plan permits, another 2 1/2 months) after termination of employment with no further contribution obligation from the employee.

The 2007 regs do not specify such spend downs for health FSAs.

However, not addressed in the 2007 regs is whether the cafeteria plan can require continued participation in the health FSA for the remainder of the year of employment termination, where the former employee is obligated to cover the remaining annual cost of the health FSA and be able to claim reimbursement against the unused balance of the health FSA. This plan-mandated continuation to the end of the year is not the same as the DCAP spend down described in the 2007 regs.

The cafeteria plan rules do specify that the plan must be primarily for current employees, but incidentally may be for former employees. The plan-mandated continuation would seem to within the ambit and is not prohibited by the 2007 regs. It is also something that the National Office interpretive attorneys had suggested was do-able.

A plan that does not mandate the continuation of the health FSA to the end of the year must give the employee the COBRA continuation option, if COBRA then applies.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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Your analysis is quite thorough. You mention that the the plan could require the continued participation of the former employee, thus suggesting that the employee is "required" to continue to make contributions in order to tap his prior contributions. Could the plan simply allow the former employee to tap his prior contributions w/o requiring him to make additional contributions? If so, is he limited to the amount of his prior contributions or the entire amount that he elected to defer for the coverage period.

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Allowing the former employee to tap his prior contributions w/o requiring him to make additional contributions is a spend down per the 2007 regs, and that is only allowed for the DCAP, not the health FSA.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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smm, just a thought to add. COBRA regs are often viewed as minimum standards, and an employer can choose to be more generous ("this is the least you must do for your employees," similar to what you wrote in an earlier post). Cafe regs are generally written as maximum standards, meaning these are the guidelines inside which the plan must be written in order for it to enjoy the tax-favored status that section 125 allows. It could easily be argued that a HC FSA spend down without contributions eliminates risk to the employee, negating the risk-shifting requirement necessary in order to label the plan as "insurance" (with the contributions becoming employer dollars under section 106, and the payout for eligible expenses being tax-free under section 105). Sure, some plans do allow this, but I think they are wrong, and would have a tough case in an audit.

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I just wanted to throw one thought in. The mandatory option suggested by a previous poster which would require participants to continue contributing to the Medical FSA and thereby allow them to continue incurring expenses until the end of the plan year is specifically prohibited by the IRS. This arrangement would eliminate all risk to the employer and negate the uniform coverage requirement. Maybe I didn't understand what the poster was suggesting but that is how I interpreted the suggestion. The original poster would be safer not implementing such a mandatory process. I think the previous references to COBRA address any sort of "spend-down" process for a Medical FSA. The primary difference in this situation is the Uniform Coverage rule which applies to the Medical FSA but not to the Dependent Care FSA.

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The plan-mandated continuation to the end of the year of employment termination puts the terminating employee in the same position as those whose employment continues to the end of the year for which health FSAs are elected. Just like the continuing employee, the terminated employee whose health FSA is plan-mandated to continue to the end of that year has to fund the remaining annual cost elected for the health FSA and is yet able to claim reimbursement against the unused balance for medical expenses incurred by the end of that year. If the plan-mandated continuation is problematic, then health FSAs for all those that continue their employment to the end of the year for which the elected the health FSA would also be problematic.

The entire elected amount for the plan year is available from day one of the plan year. That's not affected by the plan-mandated continuation. So the uniform coverage is not impacted.

As for the risk, it is from the employee's perspective that 125 is concerned, as 125 is an exception to taxation simply because the employee has the choice of cash or nontaxable benefits. With or without the mandatory continuation, the requirement for health FSAs that they be for 12 months, that the election be before the year begins, and only be changeable during the year if a 'change in status' occurs apply equally to plan-mandated continuation as to plans that don't mandate such continuation. The employee decides an amount before the 'period of coverage', commits to paying it like a premium, but bears the risk of losing so much of it as he or she does not have in qualifying expenses for the 'period of coverage' to be reimbursed. The risk is yet there for the employee that he/she will forfeit part of the elected health FSA that he/she pays for, should he/she have less in qualifying medical expenses. That is just as true for the health FSA of a terminated employee that the plan mandates be continued to the end of the plan year as it is for the employee who remains employed to the end of that plan year.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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The concept of plan-mandated participation after termination has been debated on this forum (and elsewhere, obviously) from time-to-time over the years. The IRS has not given any specific and binding guidance on the issue that I have seen. It is an area that is open to interpretation, but, for what it is worth, I would contend that the prevailing or more common interpretation is that plan-mandated participation after termination is not allowed (or at least not written into plans, perhaps due to the confusion that surrounds the issue). While that doesn’t automatically make this interpretation correct, it does illustrate industry trends, or more “normal” benefits practices.

Plan-mandated participation after termination does put the terminated employee in the same position as a regular, employed individual. In that sense, it doesn’t remove any employer risk that would otherwise exist between employees and employers.

When you look at the Plan on the whole, however, without plan-mandated participation after termination, the employer has a risk within each participant that that participant might terminate during the year without making any further contributions. That risk is hidden within each participant. The question becomes: Is that a risk that the regs infer that the employer should bear, or is normal to bear? It’s worth pointing out that this is a risk that an employer bears in regular health coverage, as well. The employee terminates, contributions cease, and coverage ceases. "Premiums" paid may or may not be more than the claims paid up to that point. It is not normal to have regular health coverage continue past termination (without COBRA, of course). The HC FSA is the same in that the employee dollars are turned into employer dollars under 125, then the employer uses that to buy health coverage under 106. In this interpretation, the HC FSA should not be treated differently from regular health coverage when it comes to terminations, and the plan should not mandate participation after termination.

Either way, this is certainly an area that is open to interpretation, and it would be nice to have guidance from the IRS.

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