DataPath has been receiving many inquiries about the recent legislation providing an additional two months to incur and receive payments for expenses under a Flexible Spending Account. (Click here to read the article in last month's newsletter giving the details of this legislation.) We hope that this article will answer any questions you may have.

Even small changes create ripples, and this change certainly does. Here are some of the administrative challenges that we expect to meet:

When an Employer plans to add an HDHP/HSA in the upcoming year to an existing § 125 Cafeteria Plan.  As you may be aware, participation in a general-purpose FSA causes an individual to be ineligible to contribute to a Health Savings Account (HSA), even if the participant has exhausted the FSA prior to the grace period. Therefore, employers who intend to offer an HDHP/HSA combination under their § 125 cafeteria plans in the upcoming year should proceed with caution when adopting the grace period. Here are some scenarios that these employers can consider as options:

• Employers who adopt an HSA in 2006 can choose not to adopt the FSA grace period until 2006, although these employers are likely to be under employee pressure to add this flexibility.
• The employer can instead convert the FSA to a limited-purpose plan for dental and vision expenses or could allow employees to waive submission of claims during the grace period. This would allow employees to maintain their HSA eligibility.

Additional time to submit claims after end of the new grace period. ·  Administrators and employers must decide if they how much additional time after the end new grace period to allow the employees to submit claims. For example:

• An employer presently has a § 125 plan ending December 31, 2005 with March 31, 2006 deadline to submit claims (traditionally called a “run-out period”). If an employer adopts the 2½ month grace period, the run-out period would move to May 15, 2006 (2½ month grace period + 3 month run-out period). This would result in a shorter time frame for completing the § 125 underlying health plan Form 5500 which is generally due seven months after the end of the plan year. Employers can either shorten or drop the run-out period.

Payment Source for expenses incurred during grace period. IRS Notice 2005-42ndicates that qualified expenses incurred during a grace period would be paid first from the unused amounts from the prior year, and then from the current year contributions. In certain instances, however, this “first-in, first-out” method of allocating grace period expenses could penalize the participant. For example:

• Mary has a $480 balance left in her calendar year § 125 plan on Dec. 31, 2005. Because of the new grace period, this amount would “roll over” for 2½ months at the start of 2006. On Jan. 5, 2006, Mary pays $120 for flu shots for her children. Because expenses incurred during the grace period are paid out of the prior year’s unused balance first, the $120 would have to be paid out of the unused $480 from the 2005 plan year, leaving a 2005 balance of $360. On January 31, 2006, Mary’s administrator receives a $500 paper claim for a dental procedure on Dec. 29, 2005. Because the dentist visit occurred in 2005, Mary is only eligible to receive the remaining $360 balance from 2005, but no amounts from 2006 can be used to reimburse the remaining $140. If the flu shots had been paid from Mary’s 2006 contributions instead of from her unused amounts from 2005, she could have been reimbursed for the full cost of her dentist visit.

Potential increase in administrative costs.  benefit administrators need to be aware that there will likely be additional administrative costs resulting from the increased complexity of administering continuously overlapping plan years. For instance, here is one scenario that will need to be addressed:

• Many § 125 plans use participant forfeitures to  pay for administrative costs, but a reduction of these forfeitures will very likely result from adopting the grace period. Administrators and employer need to be aware of this possibility and make plans.

So you can see, there are myriad complexities involved in this seemingly small change in the regulations. We at DataPath, Inc. are committed to developing the best software solutions for our clients, and are currently hard at work on updates to our software to meet these challenges.