Flexible Spending Account (FSA) Chapter 40 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company1 What is it? A type of cafeteria plan that is funded though salary reductions elected by employees each year Employees choose between cash and specified benefits

Flexible Spending Account (FSA) Chapter 40 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company2 When is it indicated? 1.Employer wants to expand employee benefit choices while limiting additional cost to company 2.Employee benefit costs have increased and employer must impose additional employee cost sharing 3.FSA provides tax benefit for employees not available elsewhere 4.Employer has sufficient number of employees, usually 25 or more 5.FSA benefits cannot be provided to self-employed persons

Flexible Spending Account (FSA) Chapter 40 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company3 Advantages 1.Gives employees choice between cash or benefits 2.Funded through employee salary reduction, employer has no additional costs except administrative costs 3.Employer-paid payroll tax may drop since taxable payroll is reduced 4.Salary reductions to fund nontaxable benefits under plan are not subject to federal income taxes 5.Large list of potential nontaxable benefits under plan; including benefits not otherwise available to employee (e.g. dependent care)

Flexible Spending Account (FSA) Chapter 40 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company4 Disadvantages 1.FSA must meet complex nondiscrimination require- ments imposed on cafeteria plan—administrative costs increase 2.FSAs require employees to evaluate own benefit situation and file timely election form every year –can be confusing and difficult –unused funds are forfeited at year end

Flexible Spending Account (FSA) Chapter 40 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company5 Disadvantages 3.Administrative costs higher than in fixed benefit plan 4.IRS proposed regulations require an employer to be ‘at risk’ regarding total annual amount employee elects to allocate to health benefits under his or her FSA

Flexible Spending Account (FSA) Chapter 40 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company6 Design Features 1.Generally, complex nondiscrimination rules are met if –all employees are allowed to participate –benefits as a percentage of compensation are roughly equal across employees –cost of noncompliance is loss of tax advantage for highly compensated employees 2.Allowable benefits same as for cafeteria plans can include –medical reimbursement for items not covered in health insurance plan –dependent care reimbursement

Flexible Spending Account (FSA) Chapter 40 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company7 How it Works: Basic Features of FSA Plan 1.Employer decides what benefits to provide in FSA and adopts written plan to provide these benefits 2.Employer advises employees to review their benefit needs near end of year and estimate next year’s expense items 3.Before year end, employees file written election to reduce salary and allocate amount among plan benefits

Flexible Spending Account (FSA) Chapter 40 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company8 Design Features 2.Allowable benefits same as for cafeteria plans (cont’d) Cannot include –health insurance premiums –Archer medical savings account contributions –scholarships and fellowships (Sec 117) –educational assistance under Sec. 127 plan –employee discounts and fringe benefits (Sec. 132) –deferred compensation other than Sec. 401(k) –long term care insurance

Flexible Spending Account (FSA) Chapter 40 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company9 Tax Implications 1.Employee salary reductions applied to nontaxable benefits are not subject to income tax –highly compensated lose tax advantage if plan discriminatory –must declare salary reduction in year before compensation earned 2.Employer gets tax deduction for amounts paid to reimburse employees for covered expenditures

Flexible Spending Account (FSA) Chapter 40 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company10 Tax Implications 3.Employer’s payroll subject to payroll tax is reduced by amount of any employee salary reductions under FSA - payroll tax includes –FICA (social security) –FUTA ( federal unemployment tax) –state unemployment tax –worker’s compensation

Flexible Spending Account (FSA) Chapter 40 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company11 ERISA Requirements Written plan Summary plan description Formal claims procedure Also ERISA requirements applicable to the various individual plans in the FSA still apply

Flexible Spending Account (FSA) Chapter 40 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company12 How to Install a Plan Before FSA plan can be in effect, employer must –design plan and salary reduction forms –formally adopt FSA plan and plans within FSA –communicate plan to employees –provide salary reduction forms to employees before end of year

Flexible Spending Account (FSA) Chapter 40 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company13 Application Questions Robin Hays earns $38,000 per year and is covered under an FSA plan. On December 31 of last year, Robin filed an FSA election with her employer to reduce her salary by $2,500. Robin’s benefit expenses for this year are: –$200 per month for health insurance premiums –$2,400 for dependent care under her employer’s dependent care plan –$150 for deductible under company health care plan –$100 dental work

Flexible Spending Account (FSA) Chapter 40 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company14 Application Questions 1.Considering these expenses in total, what is the dollar amount that the FSA will cover? 2.What is the tax consequence to Robin for covering benefit expenses under her FSA? 3.Given knowledge of this year’s expenses, what amount of salary should Robin elect to defer under her FSA next year?

Flexible Spending Account (FSA) Chapter 40 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company15 Application Questions 4.Suppose Robin’s mother comes for an extended visit and Robin’s dependent care expenses fall to $1400 instead of the expected $2400. Explain how that change in Robin’s expenses will affect a.the amount her FSA covers b.the amount Robin has in her FSA at year end c.the tax consequences for Robin for covering benefit expenses under her FSA d.the amount of salary she should elect to defer next year, assuming her dependent care expenses remain at $1400.