In mid-November 2018, the IRS announced its 2019 FSA limits.
Employees who pay for their health care with a flexible spending account, or FSA (and also known as a flexible spending arrangement), will be able to contribute up to $2,700 to their FSAs in the new year — an increase of $50 from 2018’s $2,650 limit.
The announcement came later in the fall than it usually does, so some employers have already locked in their employees’ FSA contribution amounts based on the 2018 limit. But employers that have already finalized open enrollment have the option to reopen the FSA election process and allow employees to set their contribution limits at up to $2,700 for 2019.
How Does a Health Care FSA Work?
According to IRS rules, an employee can contribute a portion of their pretax income to an FSA and then use it throughout the year to pay for qualified medical expenses. The full amount that the employee opts to contribute is available for withdrawal as of the first day of the plan year, even though the actual contribution is spread out across the full year’s paychecks. Employees have to decide during open enrollment how much they want to contribute during the coming year — it’s not something they can change during the year, unless there’s a qualifying event.
Employers can set their own FSA contribution limits for employees, as long as they don’t exceed the cap set by the IRS. Employers can also contribute to their employees’ FSAs, although employer contributions are limited as well: The maximum allowable employer contribution is either a match of the amount the employee contributes or $500, whichever is greater.
Most employees are familiar with the concept of “use it or lose it” when it comes to FSA funds. In general, employees have to use up their FSA funds during the year, as leftover amounts are forfeited. But the IRS allows employers the option of offering either a grace period or a carryover. With a grace period, an employee gets an extra two and a half months after the end of the plan year to use up the remaining balance in their FSA. With a carryover, the employee can keep up to $500 in remaining FSA funds and use it at any point during the next plan year. Be sure to clearly communicate whether you offer a grace period or a carryover, since that’s an essential detail when employees are deciding how much they should contribute to their FSA for the coming year.
How Much Should an Employee Contribute?
Because of the “use it or lose it rule,” some employees may want to contribute less than the maximum amount, regardless of raised 2019 FSA limits. If they think there’s little chance that they’ll end up with medical expenses during the year, they may worry that they’ll be wasting their money if they let it linger in an FSA and then forfeit it at the end of the year.
But there might be things that your employees already buy — using after-tax dollars — that could be purchased with pretax dollars instead if they had money in an FSA. This includes sunscreen (SPF 15 or higher), bandages, lip balm, first-aid kits, condoms and orthotic shoe inserts, among other items. Of course, things like eyeglasses (including prescription sunglasses), dental care and copays for office visits or prescriptions can also be paid for with FSA funds, and FSA money can be used to cover expenses that count toward the employee’s deductible.
It’s also helpful for employees to see concrete examples of how much they can save by using pretax FSA dollars instead of paying medical expenses with after-tax dollars. Consider an employee whose income puts them at a 15 percent effective income tax rate and who knows that they’ll have at least $2,700 in qualified medical expenses in 2019. If the employee doesn’t contribute to their FSA, they’ll need to earn almost $3,500 in order to have $2,700 available, after taxes, to pay for their medical expenses. That’s because 15 percent of that money will go to income tax, and 7.65 percent will go to Social Security and Medicare taxes (FICA). On the other hand, if they contribute $2,700 to their FSA over the course of the year, they’ll get to avoid paying that $800 in taxes and only have to earn $2,700 to cover their $2,700 in medical expenses.
The extra $50 in the FSA contribution limit for 2019 isn’t a huge amount of money, but it gives you an opportunity to revisit your strategy for communicating FSA benefits to employees. And when you clearly communicate details about flexible spending account rules, including how employees can use FSA funds and the advantages of using pretax dollars whenever possible, your employees are better able to take full advantage of the benefits available to them.
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