California Law Requiring FSA Notices Poses ERISA and Plan Design Issues

A new California law requires employers who sponsor flexible spending accounts (FSAs) to notify employees of any deadline that requires them to withdraw FSA funds before the end of the plan year. Although the law is only three sentences long, it raises significant questions about how to comply, not to mention questions concerning ERISA preemption.

What’s an FSA?

FSAs are employer-maintained accounts, usually funded by employee pre-tax salary deferrals, which can be used to pay specific expenses on a tax-free basis. The law covers FSAs established to pay for health care expenses, dependent care, or adoption expenses.

Employees can generally submit reimbursement requests on paper, electronically, or by use of a debit card. An employee who works the entire year can routinely submit reimbursement requests throughout the year and, typically, for a “run-out” period thereafter.

Why the New Law?

The law appears to be designed for a situation where the employee terminates employment or otherwise loses eligibility during the year, and perhaps where the employer terminates the FSA mid-year due to a sale or closing of the business. Health FSAs cannot cover expenses incurred after a participant’s termination (unless the participant exercises a limited COBRA right), but are allowed to, and often do, permit participants to continue to submit claims for expenses incurred prior to termination for a specified run-off period.

Dependent care and adoption assistance FSAs are allowed, but are not required, to let the participant continue even after termination to “draw down” the account for expenses incurred during the plan year. The new law requires that employers notify plan participants, in writing, of these deadlines.

Who Must Comply?

If the FSA plan design allows participants to submit claims for allowable expenses at least through the end of the plan year regardless of their employment status, no notice is required. If the plan design provides for a mid-year cutoff, then a notice is required, which raises other considerations.

First, health FSAs are clearly employer-maintained plans subject to ERISA, and therefore the state law will be preempted. (This would not be true for employers exempt from ERISA, such as local governments and some church plans.) However, because California agencies have been reluctant to recognize ERISA preemption without a court ruling, it may be easier simply to comply.
In any case, dependent care and adoption assistance FSAs are not ERISA plans and so would be subject to this law.

What Form of Notice Is Required?

The law requires that notice be given in two forms, only one of which may be electronic. Thus either mailing or in-person notice also is required. The law does not specify the timing or content of the notice.

It seems likely that the intent is for employers to warn terminating employees if they have to submit claims quickly to avoid forfeit of an FSA, so providing notice at the time of termination seems especially important. However, since the law does not specify, employers may decide to include the notice in a Summary Plan Description (SPD) as well as in another form of annual communication.

Providing notice (in two forms) at the time employees enroll in the FSA plan may also be prudent.