Earlier this year, the IRS provided much needed guidance regarding COBRA’s application to Health FSA plans with the carryover feature in IRS Notice 2015-87. The guidance largely confirmed our understanding of the issues. As background, Health FSA plans are group health plans subject to COBRA. Just like major medical, dental, and vision plans, employers generally must offer beneficiaries the opportunity to continue participation in the Health FSA, if coverage is terminated as a result of a COBRA qualifying event.
However, most Health FSA plans qualify for Limited COBRA, which has more relaxed COBRA requirements than full COBRA required to be offered for all other group health plans. For example, continuation coverage for a Health FSA is only required to be offered to potential beneficiaries, if the beneficiary has underspent her FSA for the plan year. In other words, the employer only needs to offer COBRA for the Health FSA if the employee has contributed more to the plan than she has been reimbursed for the year. In addition, FSA plans that qualify for limited COBRA are only required to offer the beneficiary coverage for the remainder of the current plan year, rather than the standard 18 month maximum coverage period.
When the carryover feature was introduced in 2013, there were several outstanding questions about how carryover affected the COBRA analysis for Health FSAs. Should the carryover be considered when determining whether an individual underspent her account? Should the carryover be taken into account when determining the applicable COBRA premium? Can a COBRA beneficiary take advantage of carryover even though coverage generally terminates at the end of the plan year? Fortunately, Notice 2015-87 provided clarity to many of these issues, which are discussed in the questions and answers below.
Q. Should the carryover amount from a prior year be included as unreimbursed contributions when determining whether an employee has underspent her FSA during the plan year?
A. Yes, FSA plans must take into account unreimbursed carryover funds when determining whether the account was underspent. For example, an employee has $500 carryover from Year 1 and elects to salary reduce an additional $2,400 in Year 2. After 6 months, the employee terminates having made $1,200 in FSA contributions and been reimbursed $1,500 for eligible expense. In order to determine whether the employee has overspent the account, and therefore, should be offered COBRA continuation, the $500 carryover funds must be added to the $1,200 current year contributions. Since the $1,500 of reimbursed expenses is less than the total contributions including carryover ($1,700), the employee has underspent the account and COBRA should be offered. Note, the result would be different if the plan incorrectly did not consider the outstanding carryover funds.
Q. Can the carryover amount be considered when determining the applicable COBRA premium for the Health FSA?
A. No, the plan can only charge a COBRA premium based on the current year election. Therefore, the COBRA premium would take into account the employee’s maximum benefit without consideration of any carryover funds. For example, an employee has $500 of carryover from Year 1, makes a new $1,200 election in Year 2, and contributes $100 monthly to the FSA. If the employee is offered and elects COBRA, the monthly premium would be $100 (+2%) even though the employee would also have access to the carryover from Year 1. Remember, the employee contributed those carryover funds in Year 1.
Q. Is a Health FSA subject to limited COBRA obligated to allow the COBRA beneficiary the right to continue COBRA coverage beyond the plan year in which they terminate if they have funds remaining at the end of the year?
A. Yes, if a Health FSA offers carryover for similarly situated active employees, the plan must also allow COBRA beneficiaries the opportunity to carryover funds to the next plan year, even if the plan is only required to offer limited COBRA. This is a modification of the limited COBRA rule that coverage only needs to be provided through the end of the plan year. Note, the beneficiary can only continue coverage beyond the current year to utilize the carryover funds. The plan does not need to allow the beneficiary to make a new election for the following plan year. In no event is the plan obligated to extend Health FSA coverage beyond the maximum COBRA coverage period.
In addition to the COBRA issues outlined above, Notice 2015-87 also clarified two points about carryover for active employees. First, a health FSA can condition the ability to carryover unused funds on participation in the health FSA the following year. In other words, the plan can require employees to make an election in the new plan year in order to access carryover funds. Second, a plan may limit an active participant’s ability to carryover funds to a maximum period.