How to Handle FSA Contributions During a Leave of Absence

Occasionally we find that an employee must take an approved unpaid leave of absence. Perhaps an employee and/or dependents have a medical issue and the employee needs to take an extended time off.  Or maybe an employee wants to leave on a 3 week vacation, but doesn’t have enough vacation time saved up.  Whether the employee is eligible to take unpaid, job-protected leave under the Family and Medical Leave Act (FMLA) or not, if they have an FSA account there is the question of how to fund the FSA while they are out.

Here are your three options for when your employees are on leave and you won’t be able to pull the regular payroll contribution because they aren’t receiving their regular paycheck.

The Prepay Option

The employee may pay, before commencing the leave, the contributions that would have normally been paid during the leave period. The employee choosing this option voluntarily elects to reduce their final pre-leave paycheck, or to make special salary reduction contributions that will cover their share of the contributions for all or part of the expected duration of the leave. The employee’s regular salary reduction election for the duration of the leave is then suspended, but the benefit election remains in force. When the leave ends, the employee’s previous salary reduction resumes for the duration of the plan year.

• The prepay option works best when the employee is able to plan well ahead for the leave.
• The prepay option may not work as well if the leave is expected to be of long, or indefinite duration, or if the employee does not have enough compensation to prepay the additional amounts.
• If the leave straddles two plan years, only the current plan year may have the contributions prepaid. The exception to this rule would be if the employer has a grace period. If a grace period is written into the plan document, the prepay option would be allowed during that grace period also. Treas. Reg. $1.125-3, Q/A-5(b).

The Pay-as-You-Go Option

The employee pays their normal contribution that was previously being taken as a salary reduction, to the employer. This is a post-tax contribution. If they are using their unused sick or vacation days to fund the leave, the contributions may then be pre-tax. These payments are to be made in installments during the leave. When the leave ends, the employee’s previous salary reduction election resumes for the duration of the plan year.

• If the employee fails to make the installment payments, the employer is allowed to recoup those payments upon reemployment, using the catch-up option.

The Catch-Up Option

The employer and employee agree in advance that the employer will advance payment of the employee’s FSA contributions during the leave, and that the employee will pay the advanced amounts when they return from the leave. Once the employee returns from the leave, they make special catch-up salary reduction contributions to cover the FSA contributions that were missed while they were on leave. Upon return, the normal salary reductions resume for the duration of the plan year. These catch-up contributions may be pre-tax if they are taken from the compensation of the employee.

• If the employee does not make the required contributions while on leave, the employer may use the catch-up option to recoup the employee’s share; even without the employee’s prior agreement.
• If the leave straddles two plan years the catch-up contributions may still be taken as pre-tax.
• There is an added risk to the employer as the employee is allowed to spend up to the entire election amount for the plan year. The uniform coverage rule is not suspended.