A Complete Guide to Flexible Spending Accounts (FSAs) for Small Businesses
- Small Business Benefits
- Dec 18, 2024
- 6 min read
Updated: Feb 18
When it comes to employee benefits, small businesses often face challenges in balancing affordability with value. Flexible Spending Accounts (FSAs) can be a powerful tool for small businesses looking to enhance their benefits package without incurring massive costs. Not only does it save employees money on healthcare, but it also offers employees with a pre-tax way to pay for eligible medical expenses.
Plus, offering an FSA doesn’t impact an employee’s ability to secure individual health coverage on the ACA exchange. But what exactly is an FSA, and how can your small business use it to attract and retain talent?
Table Of Contents
Whether you're hearing about FSAs for the first time or considering them as part of your benefits offerings, this guide will walk you through everything you need to know. We’ll break down how FSAs work, their advantages for small businesses, and how they fit within the larger healthcare landscape.
What Is an Flexible Spending Account and How Does It Work?
Think of an FSA as a pre-tax piggy bank for health-related expenses. Employees set aside a portion of their income before taxes to pay for qualifying out-of-pocket healthcare costs.
Here's what FSAs typically cover:
Co-pays, deductibles, and prescription medications.
Dental or vision expenses like braces or glasses.
Certain over-the-counter medical supplies (subject to IRS rules).
Key Features of FSAs:
Pre-Tax Advantage: Contributions are made before taxes, reducing taxable income for employees and lowering payroll taxes for employers.
Annual Election: Employees decide how much to contribute annually, up to the IRS limit (e.g., ~$3,050 in 2023, limits are adjusted annually).
Use-It-or-Lose-It Rule: Funds must be used within the plan year or a designated grace period; unused amounts may be forfeited depending on plan terms.
Example: John, an accounting assistant, sets aside $1,500 annually in his FSA. This allows him to pay for his daughter's orthodontic treatment and routine vision exams without worrying about unexpected out-of-pocket expenses.
A Special Note on Dependent Care FSAs
In addition to the healthcare plan, a Dependent Care FSA can help employees manage childcare or adult dependent care costs. These accounts have distinct IRS rules and contribution limits, offering employees even more flexibility.
Why Should Small Businesses Offer Flexible Spending Accounts?
If you're a small business owner looking for cost-effective ways to enhance your benefits package, FSAs are worth considering. Here’s why they make sense:
Cost-Effective Benefit
Offering an FSA doesn’t require out-of-pocket contributions from employers. Your primary costs include setup fees and administration, keeping it budget-friendly.
Tax Savings
Employers reduce payroll taxes because employee FSA contributions come from pre-tax income. Employees enjoy tax-free withdrawals for eligible medical expenses.
This means employees effectively see more of their money, while businesses benefit from lower tax burdens.
Boosts Employee Satisfaction
Healthcare costs are a constant stressor—and FSAs provide some relief by making those costs more manageable. Even if you can’t afford to offer comprehensive health insurance, an FSA shows employees you care about their financial well-being.
Improved Recruitment & Retention
Want to stand out in a competitive job market? FSAs are an attractive perk to include in job postings. Whether bundled with a health plan or offered as a standalone benefit, they show potential hires you’re invested in their well-being.
Example: One small marketing agency with 15 employees introduced FSAs as their first healthcare-related benefit. The ability to cover co-pays and prescription costs made a noticeable impact—and employees appreciated the company’s efforts, despite its limited budget for health insurance.
Flexible Spending Accounts and ACA Exchange Coverage: What You Need to Know
One concern for employers and employees is how FSAs interact with health plans bought on the Affordable Care Act (ACA) Marketplace. There’s a common misconception that if an employer offers an FSA or other health-related benefits, it might prevent employees from purchasing health insurance on the ACA marketplace (also called the exchange). Here's the key takeaway:
FSAs Are Not “Minimum Essential Coverage”
An FSA on its own does not count as a health plan that disqualifies employees from seeking coverage on the marketplace. FSAs are a tax-advantaged arrangement rather than a standalone health insurance policy.
Employees Can Still Shop the Exchange
Because FSAs don’t satisfy the Affordable Care Act’s requirement for minimum essential coverage, employees who rely solely on an FSA for their medical expenses may still be eligible to shop on the exchange.
If you don’t offer a comprehensive group health plan (or if your plan is unaffordable under ACA rules), employees might qualify for subsidies on the exchange.
Subsidy Eligibility is Unaffected
An employee’s FSA does not typically affect their eligibility for premium tax credits on the exchange. The key factor is whether they have access to an employer-sponsored group health plan that meets ACA affordability and minimum value requirements.
Takeaway: No Conflict with Market Coverage
An Flexible Spending Account is not a standalone health plan and doesn’t prevent employees from shopping on the ACA Marketplace. Employees paying for premiums or out-of-pocket costs for an ACA plan can even use their FSA funds to cover qualifying expenses.
Pro Tip: Educate your employees on how FSAs work in conjunction with ACA plans. Explain they’re designed to supplement coverage, not replace it.
Setting Up an Flexible Spending Accounts for Your Small Business
Getting started with FSAs may sound daunting, but the process is simpler than you might think. Here’s how to implement one at your company:
Choose an FSA Administrator
Partner with a payroll provider or third-party administrator (TPA) that can handle compliance, reimbursements, and employee support. Look for features like online enrollment and FSA debit cards for added convenience.
Plan Design
Define plan details such as the maximum employee contribution (up to IRS limits) and whether to allow rollovers or grace periods for unused funds (often up to $610 may be rolled over, depending on current regulations).
Employee Education
Provide clear, easy-to-understand materials about what an FSA covers, how it works, and when contributions and deadlines apply. Host a Q&A session or webinar to address questions quickly.
Example: One HR team created a 10-minute "FSA 101" video that explained the basics, shared real-life examples, and outlined deadlines—leading to a 30% increase in employee enrollments.
Ongoing Administration
The administrator will collect contributions via payroll deductions and handle reimbursements or provide an FSA debit card for employees to pay for qualified expenses.
Your administrator handles most of the heavy lifting, but make sure employees are reminded about deadlines and can access their accounts when needed.
Flexible Spending Account Best Practices & Compliance Tips
Once your FSA is up and running, these tips will help you make the most of it:
Monitor Plan Usage: Keep an eye on how many employees enroll and how they use their funds. This can inform future decisions about grace periods or rollover amounts.
Stay Updated on IRS Rules: Contribution limits and eligible expenses can change. Work with your TPA or advisor to ensure you’re always compliant.
Communicate Early & Often: Provide reminders about enrollment periods and deadlines throughout the year. Encourage employees to review their FSA contributions mid-year to ensure they’re on track.
Coordinate with Other Benefits: If you offer an HSA-compatible high-deductible plan, note that employees cannot generally contribute to both an HSA and a traditional FSA simultaneously without special provisions (like a “limited-purpose” FSA).
Key Takeaways for Flexible Spending Accounts
FSAs Are Affordable & Flexible: They’re a great way for small businesses to offer pre-tax savings on healthcare expenses.
No Barrier to Exchange Coverage: Unlike employer-sponsored major medical plans, FSAs alone don’t disqualify employees from seeking ACA marketplace coverage.
Simple Setup: With the right administrator, implementation and management can be low-hassle.
Employee Education Is Crucial: A well-informed workforce will maximize the benefits—and appreciate you for offering them.
Conclusion
Flexible Spending Accounts are a win-win for small businesses and employees alike. They offer tax advantages, boost financial wellness, and enhance your benefits package without breaking the bank. By understanding how FSAs fit into your business model, you can design a program that’s simple to manage yet impactful in building employee satisfaction.
If you’re ready to explore FSAs further, contact us to schedule a free consultation. From plan setup to ongoing support, we’ll help you tailor an FSA program that fits your needs—and your budget.
Take the first step today to create a workplace where benefits work better for everyone!
Additional Resources
IRS Publication 969: Provides official guidance on FSAs, HSAs, and HRAs
Healthcare.gov: Information on ACA marketplace plans and subsidies
Your FSA Administrator: Check with your provider for details on current enrollment deadlines, rollovers, and plan design options
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