Failed DCFSA 55% Average Benefit Test

[Christine Oliver]

We offered the new maximum DCFSA limit ($7,500), performed the test following our open enrollment period and have one HCE that elected the new maximum $7,500, that needs to be reduced in order to pass the test. My questions are:

1. Since it's possible for us to have another HCE enroll mid-year, am I correct that we have to apply the same reduction to any HCE mid-year enrollees? 

2. If yes, how do we determine what the reduced amount should be? 

3. Other than exclude HCEs altogether moving forward or setting a low election maximum, is there anything else I'm missing? 

[Brian Gilmore]

There aren't rules around how they have to adjust.  They can adjust in any manner they like as long as the total/overall/aggregate/combined HCE contributions are reduced low enough to pass the test (i.e., you get above the 55% threshold).

That said, you almost never see employers taking a different approach here.  Almost always employers will reduce HCE contributions by a uniform percentage amount.  That's pretty universally viewed as the most fair way to handle.  But again, they aren't bound by that.

The other advantage to doing the standard percentage-based HCE reduction is they can rely on the TPAs calculations to determine how much they have to reduce each HCE. 

But I think your point is specifically how to address new HCE elections mid-year after a failed pre-test, which is not an area with any set process--

1. Since it's possible for us to have another HCE enroll mid-year, am I correct that we have to apply the same reduction to any HCE mid-year enrollees?  Well you don't have to, but you should at a minimum do that.  And also I'd recommend considering going to 57.5% or 60% to provide some buffer.  Otherwise you may have to reduce HCEs again by the end of the year if the mid-year non-HCE participation rates are also not helpful.  You might also consider excluding new HCE participation for the remainder of the year if you want to keep it at 55%, that way you would be certain to pass.

2. If yes, how do we determine what the reduced amount should be?  The same percentage as the existing HCEs, at a minimum.  Again, the rules don't really care how the sausage is made as long as you get to 55%.  It's all just an HCE issue at this point, so it isn't discriminating against non-HCEs regardless of how you handle.

3. Other than exclude HCEs altogether moving forward or setting a low election maximum, is there anything else I'm missing?  An employer match for non-HCEs is an attractive option of the employer is willing to allocated budget to the dependent care FSA (rare).  Also don't forget the top-paid group (top 20%) election may be an option.  But no, I don't think you're missing anything.  These 55% average benefits test rules are always a hassle.  How you want to handle mid-year HCE elections after a failed pre-test is just a matter of how much wiggle room you think you need to pass as of the last day of the year.

More details:

- https://www.newfront.com/blog/the-dependent-care-fsa-average-benefits-test

- https://www.newfront.com/blog/the-obbb-dependent-care-fsa-increase-could-backfire

Slide summary:

Newfront Office Hours Webinar: Section 125 Cafeteria Plans

[Christine Oliver]

As always, prompt and excellent guidance! Thanks, Brian!