Healthcare flexible spending accounts (FSAs) are great ways to avoid income tax on money you use for medical expenses. The tax isn't just deferred – you never pay tax on the money if you use it for qualified expenses.
What happens to those accounts when you leave your job? There are special rules for this situation, and ignorance could be costly.
Say you signed up to put $200 a month into your FSA this year, for a total of $2400. The maximum contribution for 2015 is $2550.
You're laid off in August. You are in one of two situations: you either have a positive balance in your account, meaning you've underspent, or you've been reimbursed for more money that you've contributed at this point, so you've overspent.
Scenario #1: Underspent
You still have $1000 sitting in your FSA account when you're laid off. If you have eligible expenses that you haven't submitted yet, that shouldn't be a problem. You can still be reimbursed after your last day of work; just check to see what the deadline is for submitting them.
What if you don't have any more expenses to submit right now – you were planning to use that money for expenses you expected later in the year. If your employer is not required to offer COBRA (usually because the company has fewer than 20 employees), you could be up a creek. But if your employer is required to offer you COBRA, you still have a chance to use that money.
We usually think of COBRA as the law that entitles us to keep our employer health insurance after we leave a job, if you pay the full cost plus 2% (more to come on health insurance when you leave your job in a future post). But COBRA also lets you keep your FSA account, if you are underspent and you elect to continue making monthly contributions and pay a 2% fee. You can elect COBRA for your FSA whether or not you choose to continue your health insurance. One thing that changes with your FSA contributions under COBRA is that you won't get a tax deduction for them.
Your goal is to keep the account open just until you have enough expenses to deplete the account. Once you've paid the orthodontist, gotten new eyeglasses for the family, or had the root canal, there's no need to keep paying. Plus, you might only be able to keep your FSA account until the end of the year instead of the full 18 months usually required by COBRA, because of some arcane rules.
Scenario #2: Overspent
You already submitted and have been reimbursed for $2400 of expenses. But you've only contributed $1600 so far this year, so your account is in the hole.
You were within the rules: you can submit and be reimbursed for expenses up to your year's contributions at any time during the plan year. It doesn't matter that your reimbursement is more than you had contributed at that point.
Apparently, it also doesn't matter if you're overspent at the time you're laid off, retire, or quit. All of the sources I read agreed: it is either impossible or highly unlikely that your employer could ask you to cough up the difference. I did, however, see comments from a few employees whose employers tried to collect the balance from them.
Other Types of Flexible Spending Accounts
The rules discussed here apply only apply to healthcare flexible spending accounts. You may have also have separate FSAs for dependent care and commuter expenses. Ask your benefits manager or check the document that spells out all the rules for your specific plan, the Summary Plan Description, to see what rules apply to your plan.
Next month: Health Savings Accounts.
This post is part of a series about the decisions faced during a job transition, whether you're being laid off, retiring, or moving to another job. The initial post lists some of the topics I'll address, as well as why I'm writing about this issue. You can find other posts in this series by clicking the category Job Loss on the right side of this screen. Or you can subscribe to our monthly e-newsletter, which provides links to all of our new blog posts.