Reader: My husband was recently laid off from a large company, but he’s still officially an employee until late March. He’s not expected to work, but gets his regular paycheck and benefits as if he were an active employee. After he is “officially” let go, he will receive 12 weeks’ severance, and the company will contribute to COBRA health-care coverage.
Yesterday my husband read an article about a little-known loophole in the rules governing his health-care flexible spending account (FSA) for medical expenses: If you are terminated or leave your job for whatever reason, you can use the entire FSA elected amount before your job termination date even though you have not yet contributed the full amount.
We made an FSA election totaling nearly $3,000 for this year, funded from his paycheck and partially matched by his employer, which was available to us to use on Jan. 1. It seems that under this loophole, we can use the entire amount before his official termination date even though he has only contributed a few hundred dollars so far. My question is whether the company can reduce his severance payment to make up the difference between the FSA funds we spend and the amount he has contributed.
Karla: I wouldn’t call it a “loophole” so much as “how the game is played.”
FSAs are a great way to set aside tax-free money for medical needs, but they’re also a bit of a gamble. Under the use-it-or-lose-it rule for FSAs, if an employee doesn’t manage to spend the funds set aside in the FSA before the company’s annual deadline, most of what’s left over goes back to the employer, although a small amount may be carried over to the next plan year. (The government loosened this rule somewhat during the pandemic, but the more generous guidelines have expired as of 2023.)
But, as you’ve discovered, there’s also a risk to the employer: Under what are known as the uniform coverage rules, the entire amount an employee elects to set aside in an FSA has to be available to the employee on the first day of the plan year, regardless of how much the employee has contributed toward it. If the employee spends that entire amount, then leaves the company before making all the remaining scheduled contributions for the year, the employer ends up paying the difference. Furthermore, the employer can’t recover that shortfall by, for example, taking bigger bites out of the employee’s pre-termination paychecks. Those are the rules, and employers that offer FSAs know them going in.
As for whether your husband’s employer can reduce his severance payment by the amount he has yet to contribute to his FSA, bear in mind that in most states, it’s generally up to the employer whether to offer severance and in what amount, usually based on time worked. So it’s theoretically possible for employers to reduce severance pay — but it’s unlikely, experts say.
“I am having a hard time [imagining employers reducing severance] from an operational standpoint,” says Robert Ellerbrock, a partner at FisherBroyles specializing in benefits law.
For one thing, it would involve more effort than it’s worth to tinker with one employee’s severance package, especially since FSA elections are limited to relatively small amounts ($3,050 in 2023). Also, Ellerbrock notes, the employer may be making up the loss from other FSAs whose owners fail to use up their funds by the annual deadline.
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Of course, just because it’s complicated to claw back an FSA shortfall from an employee’s severance package, that’s no guarantee some employer out there isn’t petty enough to try it, or at least threaten to. But since your husband’s employer has already given him a generous heads-up about his layoff in addition to offering severance and COBRA coverage, I doubt it will try to nickel-and-dime him out of claiming the full FSA amount he’s entitled to — even if it hasn’t exactly gone out of its way to remind him that he can.
That’s probably not the ironclad yes/no answer you were hoping for. If you want to be exceedingly scrupulous, you could calculate the total contributions to your husband’s FSA until his official layoff date, and claim only that amount. But given that (1) the entire amount was his to use from the first day of the plan year, (2) it’s tax-free, unlike severance payments, (3) he would be paying his full share if not for the company’s decision to lay him off, and (4) employers tend not to offer benefits involving risks they can’t afford, I can’t see the logic in leaving a dime of it on the table.
- Since the employer is offering COBRA health-care coverage, your husband may be able to elect to continue his FSA plan along with the COBRA plan, depending on how much of his FSA election has already been spent. But then he would have to pay not only tax but additional administrative fees on his FSA contributions under COBRA.
- If you can’t schedule appointments or procedures in time to use up your FSA funds before your husband’s layoff takes effect, you can at least stock up on medications and supplies, such as backup pairs of eyeglasses and first-aid essentials. You can see what items qualify for FSA reimbursement and order them directly through FSAstore.com.
- Note that these rules apply only to health-care FSAs — not dependent-care FSAs or health-savings accounts (HSAs), which allow you to claim reimbursement only for amounts you have already contributed.