The IRS recently released IRS Information Letter 2016-77 relating to cafeteria plan forfeitures. As background, IRS information letters are not considered formal guidance, but do provide insight into how an IRS representative may view or rule on a certain issue.
The letter is in response to an individual who asks what is done with the funds remaining in a Section 125 cafeteria plan if the plan terminates in its entirety. The IRS explains that the plan document must be reviewed for any governing terms. Specifically, the sponsoring employer or board of directors must have reserved the right to amend the plan in the written plan document, and the amendment terminating the plan must be adopted in writing and participants notified.
The letter also addresses a specific employee’s health FSA contributions, which are forfeited upon termination of employment. A plan may provide for a run-out period during which the participant may submit claims that have already been incurred. If the account is underspent at termination, the participant should be offered the opportunity to continue coverage through COBRA. If COBRA is not elected and the run-out period has been exhausted, the employee would forfeit any remaining balance. The employer may use any forfeitures to provide benefits under the plan or to pay for plan administration costs.
The letter does not go into detail regarding ERISA requirements, but it is worth noting that ERISA may apply to the underlying benefits in the cafeteria plan such as medical, dental, vision and health FSA. ERISA requires that any remaining plan assets, which include participant contributions, be used for the exclusive benefit of participants and beneficiaries or to defray administrative costs. Please remember, though, that governmental and church employers are generally exempt from ERISA.
While the letter does not necessarily provide new information, it may still be helpful to employer plan sponsors.
IRS Information Letter 2016-77 »