Flexible spending accounts (FSAs) are another type of employee benefit, in this case, solely designed to save employees money through pre-tax savings on eligible healthcare expenses. Setting up an account is another employee perk that will keep existing staff in the company favor and help attract top talent later.

According to Jody L. Dietel, chief compliance officer of Vista, California-based WageWorks, an independent provider of consumer-directed spending solutions and services, flexible spending accounts are pretty straightforward in their overall goal: help employees save money on healthcare costs they know they will likely incur. At the same time companies save a little on the taxes they pay. The account, she says, is basically "a tax-advantaged account whereby an employee makes an election (up to a maximum dollar amount established by the employer) that is available throughout the plan year (January 1 to December 31) to pay for out-of-pocket medical, dental, and vision expenses."

The advantage here for employees who elect to participate, is that the predetermined election to the plan is not subject to federal and state income tax nor is it subject to FICA and Medicare tax withholdings. Therefore, employees receive the tax savings for incurred expenses and an increase in their spendable income.  Employees appreciate the ability to use pretax dollars to fund eligible health, dental and vision expenses not covered by their health plans.  On the other hand, if employees do not use the entire amount they put into the account by the end of the calendar year they risk losing the remaining balance, Dietel notes.

How to Set Up a Flexible Spending Account: Understanding the Risks and Benefits

At first glance it may seem like there are only benefits for the employees.  Even though there is no federal or state mandate requiring an employer to offer a flexible spending account, there are advantages for the employer in the form of some payroll and FICA tax savings, explains Jessika Cole, executive vice president for Coldwater, Michigan-based Infinisource, an employee benefits administrator.

According to Kiernan Vaccaro, senior benefits consultant with San Diego, California -based CBIZ Benefits & Insurance Services, a professional services company offering a range of services including employee benefit management, there are additional reasons beyond tax savings why employers should offer FSAs:

•    To help offset an increase in cost sharing with employees  

•    Employers can write off administrative costs as a normal business expense

•    FSAs are a recognized employee benefit and is a key piece in a comprehensive employee benefits offering (another key benefit in recruiting and retaining employees)

Of course, where there are benefits there is risk. One of the biggest risks, Cole says, is not having enough money in the account to comply with the Uniform Coverage Rule. The rule states that on the first day of each year everyone who participates in a FSA is entitled to be reimbursed by the full amount of their annual election, regardless of whether or not the employee's full contribution has been met.

Cole offers this example: Say an employee has a $10 weekly election for a total yearly contribution of $520. But it's the beginning of the year and only $10 has been put into the account so far. On January 2 the employee goes to the eye doctor and gets an exam, contact lenses and glasses. The employee could be eligible to be reimbursed by the company up to the full $520 election immediately, even though the employee hasn't contributed the full amount, yet.

There is also a risk that the employee could resign before they have contributed their full amount and the company is responsible for the full reimbursement, says Cole. "The employer needs to evaluate their financial capabilities to ensure they can cover a high reimbursement level from the plan immediately," says Cole.
Vaccaro says these scenarios are not a common occurrence, but still a potential concern.

Dig Deeper: Flexible Spending Account (FSA)

How to Set Up a Flexible Spending Account: Calling In Support

Detailed forms, changing legislation and timely employee communication are just a few of the reasons Cole, Dietel and Vaccaro suggest bringing in a third-party administrator to set up a plan.

Vaccaro says an employers' main concern that should lead them to a third party is employee privacy.

"If a company does the administration for the plan internally, then they have access to protected health information and will be necessarily seeing information regarding medical claims and conditions when requests for reimbursement are submitted," explains Vaccaro.

She says access to this information could "certainly be problematic, especially since the person doing it may often be the person handling human resources and making decisions for which knowledge of medical conditions could theoretically influence those decisions," says Vaccaro.

Adds Dietel, "Generally, [employers] need to understand the (plan) rules, which likely means that they should seek the services of a reputable third-party administrator to handle the details. These are considered self-insured medical plans and so there are some complexities associated with the plans, like the application of HIPAA, how claims should be handled, funding rules and the like."

Vaccaro says companies must have a process for verifying and making determinations regarding the eligibility of expenses for reimbursement and appropriate denials. Further, she says, companies must be able to accurately record-keep each participants' individual account as claims are submitted, paid, and denied, must issue reimbursements, and must be able to perform the appropriate discrimination testing applicable to these plans.
"Hiring a third-party administrator to handle these programs is not expensive and certainly the recommended choice when offering a FSA plan," says Vaccaro.

 Cole agrees. "It comes down to time and money. How long will you spend doing this yourself? An employer can administer their own FSA, but a plan like this requires documentation to the Internal Revenue Service (IRS). It needs a Plan Document. FSAs are governed by the internal revenue service and the IRS mandates this document be in place. The Plan Document explains to employees things like how they become eligible, when they can enroll, how and when they can be reimbursed, etc."

Dig Deeper: Flexible Spending

How to Set Up a Flexible Spending Account: Health Care Reform

Another good reason to have your plan administered by an outside agent is pending changes to FSAs as part of the Health Care Reform bill.  Much of what may or may not happen is still "wait and see," says Vaccaro.
A few things are clear now, says Cole: Over-the-counter medications without a doctor's note, called a letter of medical necessity, which, in effect "prescribes" employee use, will no longer be allowable expenses. Also, the annual elections will be subject to a ceiling in 2011. Employers will have to determine what that level will be for their companies.

And, much later, explains Dietel, beginning in 2013, a participant's contribution to an FSA in any tax year will be capped at $2500, (currently maximum is set by employer) and indexed for inflation beginning in 2014. "Really, this makes this all the more critical to do now and maximize dollars and savings for employees," says Dietel.

While setting up an FSA does come with some risk, the resulting tax savings and employee good will outweigh such risks.

Dig Deeper: Stretching Your Benefits Dollar


FSAFEDS: Do your employees have a question about their FSA claims? Visit the U.S. government's clearinghouse for answers on benefit claims and filing deadlines.

Internal Revenue Service: The IRS' clearinghouse of documents offers guidelines for setting up Flexible  Spending Accounts and more.

Flexible Spending Accounts Online
: This non-partisan resource helps your employees better understand what they're contributing to and why.

Editor's Note: Looking for HR Outsourcing for your company? If you would like information to help you choose the one that's right for you, use the questionnaire below to have our partner, BuyerZone, provide you with information for free:

Editorial Disclosure: Inc. writes about products and services in this and other articles. These articles are editorially independent - that means editors and reporters research and write on these products free of any influence of any marketing or sales departments. In other words, no one is telling our reporters or editors what to write or to include any particular positive or negative information about these products or services in the article. The article's content is entirely at the discretion of the reporter and editor. You will notice, however, that sometimes we include links to these products and services in the articles. When readers click on these links, and buy these products or services, Inc may be compensated. This e-commerce based advertising model - like every other ad on our article pages - has no impact on our editorial coverage. Reporters and editors don't add those links, nor will they manage them. This advertising model, like others you see on Inc, supports the independent journalism you find on this site.