Do I Have to Pay Back My FSA If I Quit My Job?

Flexible Spending Accounts (FSAs) offer employees a tax-advantaged way to cover eligible medical expenses. However, when an employee leaves their job, questions arise about what happens to remaining FSA funds. Understanding the implications of overdrawn balances, unused funds, and options like COBRA can help employees navigate their financial responsibilities and benefits during this transition.

Overdrawn Balances

When an employee leaves their job, an overdrawn FSA—where they’ve spent more than they’ve contributed—can become a concern. FSAs are typically front-loaded, giving employees access to their full annual election amount at the start of the plan year, even if they haven’t yet contributed the full amount through payroll deductions.

Under IRS regulations, employers cannot require employees to repay overdrawn amounts upon termination. This risk is inherent to the design of FSAs, which are governed by Section 125 of the Internal Revenue Code. Employers must absorb these losses if an employee leaves with a negative balance.

To reduce potential losses, employers may adjust their FSA plan design by shortening the plan year or reducing the maximum election amount. Educating employees about FSA rules and encouraging responsible usage can also help mitigate risks. Providing clear information on eligible expenses and emphasizing the importance of planning contributions based on anticipated medical costs are proactive measures employers can take.

Recoupment by Employers

While employers cannot directly recover overdrawn FSA balances from employees, they often implement strategies to minimize financial exposure. Adjusting FSA contribution limits or offering plans aligned with historical usage patterns can help reduce the likelihood of overdrawn accounts. Employers may also provide employees with tools and resources, such as budgeting aids or access to financial advisors, to encourage informed and responsible FSA management.

Using COBRA for Continued Access

Employees leaving their jobs may be able to maintain access to their FSAs through the Consolidated Omnibus Budget Reconciliation Act (COBRA). COBRA allows departing employees to continue making contributions to their FSA, enabling access to funds for eligible expenses. However, this option is only available if the FSA is underspent at the time of termination—meaning the remaining balance must exceed the total contributions made up to that point. COBRA coverage for FSAs typically lasts only until the end of the plan year, unlike the standard 18-month COBRA period for health insurance.

Electing COBRA requires careful financial consideration. Employees must evaluate the cost of continued contributions against their anticipated medical expenses to determine whether this option provides sufficient benefits and tax savings.

Options for Unused Funds

When employees leave their jobs, unused FSA funds are subject to the “use-it-or-lose-it” rule, which requires forfeiture of unspent contributions. Unlike Health Savings Accounts (HSAs), FSAs do not allow indefinite rollovers, making strategic planning essential to avoid losing funds.

Some employers offer a grace period, typically up to two and a half months after the plan year ends, to allow additional time for eligible expenses. Others may include a carryover option, permitting the transfer of a limited amount—such as $610 for the 2023 tax year—into the next plan year. These provisions can help employees maximize their FSA contributions and reduce the risk of forfeiture.

Potential Tax Considerations

The tax implications of leaving a job with an FSA can vary, depending on how the account was used. FSA contributions are made on a pre-tax basis, reducing taxable income. If an employee leaves with unused funds and does not elect COBRA, those funds are forfeited to the employer. While this forfeiture doesn’t create a tax liability, it represents a missed opportunity to further reduce taxable income. Conversely, if an FSA is overdrawn, the employer absorbs the loss, and the employee faces no tax implications for the overdrawn amount.

Proactive planning can help employees maximize FSA benefits before leaving a job. Timing medical expenses to align with employment status ensures contributions are fully utilized, while coordinating FSA usage with other tax-advantaged accounts, such as HSAs, can optimize overall savings. Employers should also ensure accurate reporting of FSA contributions and forfeitures on employee W-2 forms, as required by IRS rules.