Carryover And COBRA Combinations Call For Careful Consideration

It used to be simple to determine the amount of a qualified beneficiary’s benefit available and the COBRA premium required for a healthcare flexible spending account (FSA). However, starting in 2013, healthcare FSAs are permitted to allow a carryover of up to $500 of unused funds remaining in the healthcare FSA at the end of one plan year to the following year.1

And, although they are group health plans and are therefore subject to COBRA, employers who maintain healthcare FSAs that satisfy a few particular conditions may have a limited obligation with respect to the duration of COBRA continuation for the qualifying healthcare FSA.2

While the introduction of carryover amounts added an additional factor to these determinations, the Internal Revenue Service (IRS) provided additional—and welcome—clarification with its Notice 2015-87 released December 16, 2015.3

Calculating the COBRA Premium for Healthcare FSAs, Generally
By way of background, healthcare FSAs are considered group health plans and are subject to COBRA. Under the general rules for calculating COBRA premiums, the maximum COBRA premium—referred to as the “applicable premium”—is generally the cost to the plan for similarly situated beneficiaries who haven’t experienced a qualifying event plus two percent. In the case of healthcare FSAs, the “cost to the plan” on which the COBRA premium is based is most commonly equal to the annual coverage amount the employee elects for the year. In other words, if an employee elects $1,200 under her healthcare FSA, it is reasonable to set the annual COBRA premium equal to that amount plus two percent (i.e., $1,200 x 1.02 = $1,224).

Limited COBRA Obligation for Certain Qualifying Healthcare FSAs
However, if the healthcare FSA is an “excepted benefit” and the maximum COBRA premium that can be charged for the healthcare FSA (as explained above) equals or exceeds the annual healthcare FSA coverage amount elected, a special limited COBRA responsibility may apply.

For those healthcare FSAs to which the limited COBRA responsibility applies, the healthcare FSA need not make COBRA coverage available at all for employees who—at the time of their COBRA qualifying event—have “overspent” their accounts.

To determine if a healthcare FSA is “overspent,” an employer must first consider an employee’s annual elected contribution amount for the plan year and compare that to the total amount of reimbursable claims submitted to the healthcare FSA for that plan year before the date of the qualifying event. The remaining available healthcare FSA amount for the current plan year, which is the annual contribution amount for the year less the total amount received in eligible claim reimbursements before the qualifying event, is then compared to the maximum amount the healthcare FSA is permitted to require to be paid for COBRA coverage for the remainder of the plan year.

If the employer determines the maximum COBRA premium the healthcare FSA could require as payment for the remainder of the year following the qualifying event is more than or equal to the remaining available healthcare FSA amount for the current plan year then such a healthcare FSA is “overspent” and it is not obligated to offer COBRA coverage.

To illustrate this analysis, consider the following example:

Employee Amy elects an annual contribution of $1,200 (or $100 per month) for the current plan year under her employer’s qualifying healthcare FSA, which has a calendar plan year and is funded solely by employee salary reductions.

Amy terminates her employment, and her healthcare FSA coverage ceases, on March 31. As of that date, Amy has submitted reimbursable claims totaling $285 and has made salary reductions of $300 ($100 x three months). Her employer has reasonably estimated the cost of providing the healthcare FSA coverage (the applicable premium) is equal to the annual salary reductions.

Amy’s maximum benefit available for the remainder of the plan year is $915 ($1,200—$285).

Since Amy made a $1,200 healthcare FSA election for that year, her annual COBRA premium would be $1,224 ($1,200 x 1.02); the monthly COBRA premium would be $102 ($1,224/12). The maximum COBRA premium that can be charged for the nine months remaining in the year is $918 ($102 x nine months).

Since Amy’s maximum benefit available for the remainder of the plan year ($915) is less than the maximum COBRA premium that can be charged for the rest of the year ($918), her account is “overspent.” Because the healthcare FSA qualifies for the special limited COBRA obligation and her account is “overspent,” Amy’s employer is not obligated to offer her COBRA continuation of her healthcare FSA for the remainder of the current year.4

For employees who have not “overspent” their account (that is, their remaining available benefit for the year is greater than the total COBRA premium the plan can require as payment for the remainder of the year), then the healthcare FSA need only offer COBRA until the end of the year in which the qualifying event occurs.

So, assume the same facts as in the previous example, except that Amy made no healthcare FSA claims prior to her termination of employment on March 31.

At the time of her qualifying event, the maximum benefit available for the remainder of the plan year is still $1,200.

Since the plan can charge her $918 ($102 x nine months) for the remainder of the year, the maximum benefit available ($1,200) is greater than the maximum amount the plan could require as payment for the remainder of the year ($918). In this case, Amy’s employer must offer COBRA continuation of the healthcare FSA, but the coverage may be terminated at the end of the plan year.5 No re-enrollment rights need to be offered to her during the plan’s annual open enrollment period.

However, for instances in which the healthcare FSA does not meet all the requirements to offer limited COBRA coverage, then COBRA continuation must still be offered, but coverage would continue for up to the general maximum COBRA eligibility period (18 months or longer, depending on the qualifying event).

Carryover and COBRA Eligibility
How do a healthcare FSA’s carryover provisions apply to this limited COBRA obligation?

Fortunately, Notice 2015-87 provides welcome guidance that will assist in making correct eligibility determinations—and COBRA premium calculations—for healthcare FSAs offering a carryover.

When determining if a qualified beneficiary’s healthcare FSA is not “overspent” (again, the maximum benefit available under the healthcare FSA for the remainder of the current plan year is greater than the maximum COBRA premium the plan could require as payment for the rest of the year), any carryover amount from the previous year(s) must also be included in the calculation.6

Employee Amy elects an annual contribution of $1,200 (or $100 per month) for the current plan year under her employer’s qualifying healthcare FSA, which has a calendar plan year and is funded solely by employee salary reductions. She also has $500 in unused carryover funds from the previous plan year. Therefore, as of the first day of the current year, her maximum benefit available is $1,700 ($1,200 + $500).

Amy terminates her employment, and her healthcare FSA coverage ceases, on March 31. As of that date, Amy has submitted reimbursable claims totaling $285.

Amy’s maximum benefit available for the remainder of the plan year is $1,415 ($1,700—$285). Since Amy made a $1,200 healthcare FSA election for that year, her annual COBRA premium would be $1,224 ($1,200 x 1.02); the monthly COBRA premium would be $102 ($1,224/12). The maximum COBRA premium that can be charged for the nine months remaining in the year is $918 ($102 x nine months).

Since Amy’s maximum benefit available for the remainder of the plan year ($1,415) is more than the maximum COBRA premium that can be charged for the rest of the year ($918), her account is not “overspent” and COBRA coverage must be offered.

It’s noteworthy that—in this example—the $500 in carryover funds were not included in the COBRA premium calculation, even though they were included when calculating the maximum remaining benefit available. This is because, while carryover funds are included in determining whether an account is overspent, the IRS has clarified that the maximum COBRA premium payment amount specifically does not include unused amounts from prior plan years. The COBRA premium amount is based solely on the employee’s election for that year (and any employer contributions).7

COBRA Continuation into New Plan Year
While healthcare FSAs must offer COBRA coverage to qualified beneficiaries in the event of an account that is not “overspent,” those healthcare FSAs that qualify for the limited COBRA obligation may terminate such coverage at the end of the plan year in which the qualifying event occurred. This means they are not required to allow COBRA beneficiaries to elect additional amounts at the beginning of a new plan year or access to any employer contributions.

However, if such a healthcare FSA offers carryovers for its active beneficiary population, it must—subject to the same terms—also allow any funds (up to $500) remaining at the end of the plan year to be carried over to the new plan year for similarly situated COBRA beneficiaries as of the last day of the plan year in which the qualifying event occurred. And because, as previously stated, the prior year’s unused funds are not included in the COBRA premium calculation, the applicable premium for the carryover funds for the new plan year is zero. However, while the carryover is required to be available after the end of the plan year in which the qualifying event occurred, it is also limited to the maximum COBRA continuation period (e.g., 18 months).

Let’s recall that Amy elected salary reductions of $1,200 for the current plan year under her employer’s calendar-year healthcare FSA, which qualifies for the limited COBRA obligation and allows participants to carry over unused funds of up to $500 from the prior plan year. Therefore, as of the first day of the current year, her maximum benefit available is $1,700 ($1,200 + $500).

Amy terminates her employment on March 31. As of that date, she has received $285 for submitted eligible healthcare FSA claims. Amy elects COBRA and pays the required premiums for the remaining nine months of the year. During this period, Amy continues to submit additional reimbursable claims totaling $915. By the end of the year in which her qualifying event occurred, Amy has $500 of unused benefits remaining.

Despite the healthcare FSA’s limited COBRA obligation, Amy can continue to submit claims under the same terms as similarly situated active plan participants in the new plan year (up to $500). During this period, no additional COBRA premium can be charged for the carryover funds. However, the healthcare FSA need not reimburse any expenses incurred after Amy’s maximum 18-month COBRA period expires on September 30 of the current plan year.

Carryover Limitations
Offering the carryover of unused healthcare FSA funds is at the employer’s option. An employer may opt to provide such a carryover in lieu of a grace period, especially as the IRS has previously clarified that a healthcare FSA may not provide both a grace period and allow carryover of unused funds. The carryover feature, however, is quickly becoming a standard for healthcare FSAs. For this growing majority of employers offering the carryover provision, Notice 2015-87 allows some flexibility in how it can be offered.

A healthcare FSA may limit the availability of the carryover of unused amounts (subject to the $500 limit) to individuals who elect to participate in the healthcare FSA in the next year. Employers may even set a minimum amount of salary reduction elections to the healthcare FSA for the next year. For example, employers can condition the carryover of funds to employees electing at least $60 or more to the healthcare FSA. Therefore, only employees electing $60 or more for new plan years have their remaining funds (up to $500) carried over to the new plan year. Employees not electing the healthcare FSA for the new plan year would forfeit leftover funds as of the end of the previous plan year.

A healthcare FSA may also limit the timeframe that unused amounts may be used. For example, a healthcare FSA can limit the ability to carry over unused amounts to one year. If a participant carried over $30 and did not elect any additional amounts for the next year, the healthcare FSA may require forfeiture of any amount remaining at the end of that next year.

Parting Notes
It is important to remember, when considering the COBRA implications of healthcare FSAs, that the expenses of the employee, spouse, and dependents are all generally reimbursable under a healthcare FSA. Therefore, the IRS has clarified that an employee, the spouse, and any dependent children can be COBRA qualified beneficiaries for purposes of continuing a healthcare FSA if their medical expenses are reimbursable under that arrangement. This means that an employee’s spouse and dependent children must also be offered COBRA continuation of a healthcare FSA, not just following the employee’s termination or reduction of hours of employment, but also following the 36-month qualifying events like divorce, death, or loss of dependent child status. Therefore, it’s important to determine if you have the information and processes in place to determine COBRA benefits, premiums, and distribute beneficiary notifications with respect to all qualified beneficiaries and their potential rights under COBRA, even for the healthcare FSAs.

One final point: The healthcare FSA “footprint,” rule2 has long been misunderstood and must be followed because of the Affordable Care Act market reform. All employees eligible for the healthcare FSA must also be eligible for—irrespective of their enrollment in—the major medical plan. 

The information contained in this article is not intended to be legal, accounting, or other professional advice. We assume no liability whatsoever in connection with its use, nor are these comments directed to specific situations.

References:

  1. https://www.wageworks.com/employers/employer-resources/compliance-briefing-center/legislation-and-reform/legislation-insights/2013/landmark-notice-allows-carryover-of-unused-funds/.
  2. https://www.wageworks.com/employers/employer-resources/compliance-briefing-center/legislation-and-reform/legislation-insights/2013/affordable-care-act-changes-for-flexible-spending-accounts/.
  3. https://www.irs.gov/pub/irs-drop/n-15-87.pdf.
  4. “If [benefits provided under the health FSA are excepted benefits under HIPAA’s portability provisions and the maximum amount that the health FSA can require to be paid for a year of COBRA continuation coverage equals or exceeds the maximum benefit available under the health FSA for the year], then the health FSA is not obligated to make COBRA continuation coverage available for any subsequent plan year to any qualified beneficiary who experiences a qualifying event during that plan year.” [26 CFR § 54.4980B-2, Q&A(d), emphasis supplied].
  5. “If [benefits provided under the health FSA are excepted benefits under HIPAA’s portability provisions and the maximum amount that the health FSA can require to be paid for a year of COBRA continuation coverage equals or exceeds the maximum benefit available under the health FSA for the year], then the health FSA is not obligated to make COBRA continuation coverage available for any subsequent plan year to any qualified beneficiary who experiences a qualifying event during that plan year.” [26 CFR § 54.4980B-2, Q&A(d), emphasis supplied].
  6. “Any carryover amount is included in determining the amount of the benefit that a qualified beneficiary is entitled to receive during the remainder of the plan year in which a qualifying event occurs.” [IRS Notice 2015-87, 2015 I.R.B. 889].
  7. “The maximum amount that a health FSA is permitted to require to be paid for COBRA continuation coverage (that is, 102 percent of the applicable premium) does not include unused amounts carried over from prior years. The applicable premium is based solely on the sum of the employee’s salary reduction election for the year and any non-elective employer contributions.” [IRS Notice 2015-87, 2015-52 I.R.B. 889].

Jason Folks, CFCI, is the director of compliance services with WageWorks, Inc., in Irving, TX. He has over 15 years of experience in regulatory compliance and employer consultation.

Folks attended New York University and holds a Certified in Flexible Compensation Instructor (CFCI) through the Flexible Compensation Institute, LLC, a wholly-owned subsidiary of the Employers Council on Flexible Compensation.

Folks can be reached via email at: Jason.Folks@WageWorks.com.