Can Health FSAs Be Used to Prepay for Orthodontia?

Jenny Lucey, CEBSNovember 12, 2020November 11, 2020

As fall begins, the International Foundation Information Center typically sees an uptick in requests about year-end or new year planning for calendar year plans. Flexible spending account (FSA) participants need to estimate how much they will set aside for medical expenses prior to the beginning of the next plan year. Employees may want to plan ahead for big-ticket services like orthodontia, and benefits professionals should prepare to answer questions about eligible medical expenses.

The Internal Revenue Code Section 125 regulations generally prohibit FSA plans from making advance reimbursements of future or projected expenses. The rules say the expenses must be incurred during the coverage period. The rules specifically state that an expense is not incurred just because the participant “is formally billed or charged for, or pays for the medical care.”

This post focuses on the rules for prepayment of orthodontic treatment that spans multiple years.

Short answer: FSA plans may, but are not required to, reimburse prepayments for orthodontic services, so long as the employee has actually made the payments in advance to receive the services. The employer’s reimbursement decision should be clearly explained in the plan document and SPD. The plan should consistently and uniformly administer this provision.

Flexible Spending Accounts (FSAs) E-Learning Course

Because orthodontia typically spans a period of years, individuals are often charged an initial, up-front payment and then must make periodic payments over the rest of the treatment period. This makes it difficult to match payments with service. FSA plans have two options for orthodontia reimbursement. FSA plans can choose whether or not to allow prepayment for orthodontia reimbursement. Below are examples of each option.

Option 1: Allow prepayments

Reimburse the employee for the full amount of the orthodontic expenses actually paid. Under the 2007 proposed cafeteria plan rules, orthodontic services are deemed incurred when the employee makes the advance payment.

The following example comes from the relevant regulation with years and FSA contribution limits changed.

Example. Advance payment to orthodontist. Employer D sponsors a calendar year cafeteria plan which offers a health FSA. Employee K elects to salary reduce $2,750 for a health FSA for the 2021 plan year. Employee K’s dependent requires orthodontic treatment. The orthodontist, following the normal practice, charges $2,750, all due in 2021, for treatment, to begin in 2021 and end in 2022. K pays the $2,750 in 2021. In 2021, Employer D’s cafeteria plan may [if permitted under the plan] reimburse $2,750 to K, without violating the prohibition against deferring compensation in section 125(d)(2).

Option 2: Do not allow prepayments

Reimburse the employee for the orthodontic expenses which have been provided. The plan would require a breakdown of the bill and would reimburse only those expenses that are matched with actual treatment.

Here is an example of reimbursement for orthodontic expenses incurred.

Employee K’s reimbursement for 2021 will depend on how much of the $2,750 relates to services actually provided by the orthodontist in 2021. K must ask the orthodontist to allocate the $2,750 over the visits and the supplies received during the projected full treatment period. For example, let’s say the orthodontist estimates that the initial consultation and installation of braces will cost $550 and the rest of the orthodontic treatment costs will be allocated at $100 per monthly visit. Employee K can submit a claim for $550 after the braces are installed and then continually submit a claim of $100 after each monthly visit throughout the treatment period.

[Related Reading: Pros and Cons of Flexible Spending Accounts (FSAs)]

Why would an employer prefer not to allow prepayment?

An employer may wish to reduce the risk of losses under the uniform coverage rule. (Note: The uniform coverage rule requires that “the maximum amount of reimbursement from a health FSA must be available at all times during the period of coverage.”) In the scenario above, where orthodontic expenses are reimbursed at the time of payment rather than as they are incurred, the employer would experience a loss if employee K is reimbursed in March 2021 for the $2,750 full prepayment and terminates employment two months later in May 2021.

When planning ahead for orthodontic services, employees may want to ask the orthodontist whether they have payment options (i.e., prepayment or monthly payments or both). If the employee wants to prepay or if prepayment is required, they can ask their benefits department what the FSA plan allows.

Have a question about flexible spending accounts or another employee benefit?

International Foundation members can Ask a Benefits Expert! This free member service puts you in touch with an expert who will reach your question and provide customized information on any employee benefits topic. Learn more.

Resource:
IRS Proposed Regulation on Cafeteria Plans, Sections 1.125-5(k)(3)(i) and (ii).