Beginning January 1, 2013, the Patient Protection and Affordable Care Act (“PPACA”) requires plan sponsors to limit pre-tax health flexible spending account (“FSA”) contributions to no more than $2,500 per calendar year. There are currently no limits on health FSA contributions. Thus, many employers have plan-imposed contribution limits in excess of the new $2,500 limit. This change is anticipated to be a revenue-raiser. Because the new limit is lower than most existing plan-imposed pre-tax FSA contribution limits, affected employees will pay taxes on more of their salary.
Given the January 1, 2013 effective date, many employers think they can wait until the end of 2012 to implement this change. However, plan sponsors with non-calendar year plans need to act now because this new limit is tied to the taxable year of the participant, which is almost universally the calendar year. Thus, the rule generally becomes effective January 1, 2013 regardless of whether the FSA is a calendar year plan or a non-calendar year plan. This means that employers that use a non-calendar plan year and that permit annual contributions of more than $2,500 must come up with a strategy for complying with the new limit during the transition plan year that begins in 2013.
While the IRS has not officially condoned any particular method for complying with this requirement, there appear to be are a few options as to how employers with non-calendar plan years can address this new rule.
Option 1: Impose New Limit Early. The easiest option to implement and administer is to impose the $2,500 limit as of the beginning of the 2012-2013 plan year. This would ensure that the $2,500 limit would apply for the duration of the 2013 calendar year and would prevent employers from having to make additional changes in subsequent years. If an employer selected this option, and a participant wanted to contribute the full $2,500 through evenly distributed contributions, the participant could contribute $208.33 per month.
While imposing the new contribution limit early is the easiest option to administer, this option may not be a viable choice for everyone. For example, if the 2012-2013 plan year already started, an employer would have to look to another option. Or, if an employer wanted to allow participants to maximize 2012 contributions, imposing the new contribution limit in the 2012-2013 plan year is probably not the best option. Under these circumstances, an employer may want to consider one of the remaining two options.
Option 2: Retain Current Limits and Stop 2013 Contributions When $2,500 Limit is Reached. If an employer’s 2012-2013 plan year has already started (or if an employer simply wants to allow participants to maximize their 2012 contributions), the employer could allow the current rate of FSA contributions to continue into 2013, but then cut contributions off if/when each participant reaches the $2,500 limit. To illustrate, suppose the FSA plan year runs from July 1 to June 30, and the employer currently has a $5,000 limit on pre-tax FSA contributions. If a participant elected to contribute the full amount allowed per month ($416.67), the individual would reach the 2013 limit on July 1, 2013 at which time the employer would have to cut off contributions for the remainder of the 2013 calendar year (i.e., for the first half of the 2013-2014 plan year).
On the other hand, if an employee contributed less than the full amount allowed, the individual could continue to contribute after the beginning of the 2013-2014 plan year (and up to the date he or she reached the $2,500 calendar year limit). For example, if a participant elected to contribute $200 per month to the FSA, the individual would have contributed $1,200 in 2013 as of July 1, 2013. In this case, the employer could continue to allow the participant to contribute $200 per month for the remainder of 2013 as this would only amount to $2,400 in total contributions during the 2013 calendar year.
Option 3: Prorate Contributions for Beginning of 2013-2014 Plan Year. If an employer does not want to put a hard stop on contributions in 2013, the employer could allow employees to prorate their contributions for the 2013 portion of the 2013-2014 plan year. Assume the employer has an April 1 to March 31 plan year and currently has a $6,000 FSA contribution limit. If an employee contributes the maximum amount allowed per month ($500) for the 2012-2013 plan year, the employee’s 2013 contributions would total $1,500 as of the end of the 2012-2013 plan year (i.e., as of April 1, 2013). The employee could then contribute an additional $1,000 for the 2013 portion of the 2013-2014 plan year (i.e., from April 1, 2013 to December 31, 2013). If the employer elected this third option, the employee could contribute a maximum of $111.11 per month for the remainder of the 2013 calendar year.
While Options 2 and 3 would presumably comply with the new limit (again, we are still awaiting formal guidance on this issue), these options could be difficult to administer and would still leave employers with the ongoing task of enforcing the new limit in the 2013-2014 plan year and beyond. Regardless of which option an employer chooses, we suggest (1) communicating the limits to plan participants in advance of the effective date of the change and (2) amending the plan document to specifically describe the desired approach.