FAQ: What options do employers have when dealing with health FSA and/or dependent care FSA experience gains (i.e., forfeitures)?

Under the “use-or-lose” rule, health FSA and DCAP contributions that are not used to reimburse expenses incurred during the plan year (or during a carryover or grace period, if applicable) will be “forfeited,” even if the reimbursements are less than the participant's contribution. In light of the COVID-19 public health emergency, employers may be dealing with such experience gains/participant forfeitures more so than usual given that participants may not have the opportunity to use designated health FSA and DCAP funds within the period of coverage.

Fortunately, the IRC and ERISA provide guidance to employers on what can be done with such experience gains/participant forfeitures.

  • For plans not subject to ERISA, they may be retained by the employer maintaining the cafeteria plan.
  • For plans subject to ERISA, the forfeitures may be used only in one or more of the following ways:
    • To reduce required salary reduction amounts for the immediately following plan year, on a reasonable and uniform basis
    • Returned to the employees on a reasonable and uniform basis
    • To defray expenses to administer the cafeteria plan

Practically speaking, many employers choose to use experience gains to defray reasonable administration expenses as this is generally the easiest approach to administer. Importantly, if an employer chooses to return funds to employees, experience gains may not be allocated among employees based (directly or indirectly) on their individual claims experience — it must be on a reasonable and uniform basis. For example, experience gains may be returned to all employees who elected coverage for the plan year on a per capita basis or weighted to reflect the employees' elected levels of coverage. Further, any cash returned to employees from a FSA's experience gains will be considered to be W-2 wages for purposes of FICA and federal income tax withholding.

While the IRS and DOL provide the above options, employers should be sure to follow any terms in their plan document that may dictate how forfeitures and experience gains must be applied.