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Your Take: The FSA Loophole

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Drugstore PharmaciesWhat’s the FSA loophole you ask? First, an FSA is a Flexible Spending Account and it’s an account where you can deposit funds pre-tax, they’re deducted from your paycheck. You can only use those funds to pay for qualified medical expenses. A qualified medical expenses can be anything from co-pays to prescription and over the counter medications. The only downside to the FSA is that you must spend all the funds within the plan year or they expire. Allocate too much and you find yourself wasting it on over the counter drugs you hadn’t planned on buying; allocate too little and you lose out on some of the tax benefits.

There is a loophole in the system though. Once you determine your FSA balance for the year, you can begin immediately spending it and be reimbursed. The amount you allocate is deducted from your paycheck each month so you could conceivably spend your entire year’s allocation before you even pay for it. If you were to leave your job, you wouldn’t have to pay the negative balance, between the amount spent and how much you’ve contributed, on your FSA. That’s the FSA loophole.

I’ve heard stories of people paying for entire operations (think: $$$$$) through underfunded FSAs prior to quitting their job. The idea behind the program is that the shortfalls are balanced out by the expired overages, though I wonder if they’re designed to handle extreme cases.

What do you think of this loophole? Have you ever taken advantage of this loophole? Do you think it should be closed off? If so, how? Have you heard of people paying for thousands of dollars in elective operations this way?

(Photo: dan4th)

{ 48 comments, please add your thoughts now! }

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48 Responses to “Your Take: The FSA Loophole”

  1. Peter says:

    I’m no expert, but I believe there is a way to just continue the FSA contributions without getting full health benefits. Of course, this might vary from plan to plan.

  2. Nathan says:

    Thanks I’ll look into it.

  3. Cyberowl says:

    I am in a similar situation like Nathan. I had a balance in my FSA, almost 3K. I didn’t know I could exploit this loophole that is being discussed here so I waited until I thought the FSA balance was high enough to get some needed dental work (veneer, orthodontal). Looking back, I should have just gotten the dental work in Jan.

    Come July, I found a better job. The new company made me an offer I couldn’t refuse. So I took it and quit my old company (I didn’t get laid off like Nathan did).

    Now I find out that I cannot access my FSA balance unless I pay for Cobra thru my former employer even though I have medical coverage with my new employer. The Cobra is $450/month, not cheap. While on Cobra, I have contribute to the FSA, with after-tax payments, if I want to still use my FSA balance.

    Does anyone know the answers to the following questions? I’ve consulted with my tax account, my HR person at my old company, the HR person at my new company, the Cobra adminstrator, and the FSA administrators. They all gave me the runaround and referred me to somebody else in this subgroup.

    Q1) Can I just pay for Cobra for one month, then spend the balance of my FSA and then quit Cobra and the FSA? Is there anything that requires me to continue in the FSA plan for the whole plan year? My whole plan year is from Jan. to Dec. 2008. That means $1800 in Cobra payments for me.

    Q2) My total contribute so far is about $3K. I expensed some prescription and a dental visit from FSA so I did use a little of it. Can I expense the full $5K even though I haven’t contributed all of it yet, then just quit the Cobra/FSA plan and leave a negative balance on my FSA?

    The loophole being discussed here is starting an FSA, using up all the coverage, an then quitting, which leaves a negative balance on the FSA that the employee need not pay.

    My situation is different. I want to leave a negative balance on the FSA while it is being administered thru Cobra. I’m not sure if this is possible.

    I might have to talk to the IRS about this as a last resort.

    If anyone has answers, please reply. I’m stumped here.

  4. Peter says:

    Again, I’m no expert, but I think the answer to your question is yes. You do *not* need not pay the full premium for Cobra health insurance. You only need to enroll in FSA Cobra and continue to make your FSA contribution to your old employer (plus a 2% administrative fee). As long as you are making your monthly payment and are enrolled in the FSA plan, it makes no difference if you are employed by that company or not. You can submit FSA claims up to the full amount of your annual contribution.

  5. Cyberowl says:

    I have to enroll for Cobra and FSA Cobra, right?

    I don’t think I can just sign up for FSA Cobra without signing up for Cobra. I think it’s a package deal.

  6. Peter says:

    I believe that is dependent on your employer. It is not an IRS rule. They employer is allowed to offer just FSA Cobra without the full health insurance package, but they do not have to.

  7. Anonymous says:

    I need some help on this subject ASAP.
    I pledged $2,000 for this years’ FSA, while working for the City.
    In January, I had an emergency room expense, using $590 from my FSA.
    I got laid off on February 14, having only put $260 into the FSA via salary deductions.
    I didn’t hear anything about my negative FSA balance, upon leaving.
    I was unemployed for 6 months and get hired back by the City. I pledged another $250 for the remainder of the year.
    I’ve been there 2 months now and I got a letter yesterday telling me I had a negative balance and they were going to garnish my checks for the remainder of the year to recoup there loss. End of story, no discussion.
    I’m questioning whether they can take it upon themselves to just “garnish” my check without my authorization and whether they are even able to expect reimbursement of these funds.
    Please help me..

  8. Rob says:

    Can I pay my COBRA premiums with the balance of my FSA account



  9. Cyberowl says:


    No you cannot. I had the same question and the Cobra people said that I could not pay COBRA premiums with my FSA balance.

  10. Electricute says:

    I have to agree with posters like Peter, CK, Amy and I found out about the “loophole” simply by calling my benefits hot line and asking questions. Our conversation and a bit of critical thinking led me to ask the right questions and they verified this situation.
    Many people feel this is an ethical issues but I don’t see it like that at all.
    I plan to take 100% advantage of this plan feature next year. I do not feel guilty, I feel educated.

    I have also learned from this Blog that it is always SAFEST TO USE YOUR MONEY TOWARDS THE BEGINNING OF THE YEAR. Especially when the job market is down and layoffs are common. Everyone reading this blog should take note of that! Let other peoples misfortune be a lesson learned to us all. (Sorry to hear about that too! I dont agree with use-it-or-lose-it but that is a different issue)

    Kevin, I am really trying to see your side of it because I am big on ethics…but like I said, I don’t feel at all as if this is an ethical issue, and I do not feel bad about creating my legal exit strategy that was verified legit by my benefits provider.

    Thank you all for the discussion. Keep it coming!

  11. CyberOwl says:

    Just a follow-up to my situation.

    I had a balance of $3K in my FSA. I quit in July and found out that I had to spend the balance by my last date at my former job. I could continue it by paying for the FSA monthly payments thru Cobra.

    So I paid $450 for a month for the FSA payments.

    But I spent my balance and more. I got orthodontal work that totalled $4700. My max FSA contribution per year was $5K. So I got an extra $1250 in medical FSA spending ( $4700 – $3K – $450 ).

    Nice loophole!

  12. E McCord says:

    I read several articles about this loophole. I never intended to take advantage of it, but circumstances happened to put me in a positin to leave a job after three months of the year and getting reimbursed for my dental work.

    However, my employer took the remaining negative balance of my FSA out of my next to last paycheck.

    What right do they have to do that? How do I get it back?

    • Cyber4owl says:

      I might be wrong E McCord but I thought the employer could not take a negative balance out of your paycheck.

      What if the situation was reversed? What if you had a surplus balance in your FSA and you left your job? Would you be entitled to get that surplus refunded to you? I doubt it because this is not allowed by rules governing FSA.

      It might be too late I would follow up on this with a lawyer

  13. Other side of the loop hole says:

    I just quit my job on 15th of Sept to start a new job. I contributed almost $1000.00 into my FSA account for my wife and myself. After leaving the job, my wife went to the Doctors, and I tried to submit the co-pay. The system would not accept anything after the last day of my employment with my old company. I had close to $500 left remaining in the account. After speaking to the Pay Checks, the customer rep. indicated how much ever money was left in the account will be given back to my old company (who were cheap). Now this is a serious issue, as this loop hole is never told by any HR team. Now I definitely will be “Miss using” the new FSA account. To put it simple I want my hard earned money back, and for me $500 is hard to come by.

    • Cyber4owl says:

      This is weird.

      Unless your company cancels your health insurance right on the last day of your employment, you should still have medical insurance from your old employer until 9/30.

      Since that is the case, you should be able to access the remaining $500 of your FSA.

      You should take this up with your CPA or a lawyer.

  14. Robert says:

    I found out about the loophole by accident. I set my funding to 2400 (200/month) and was laid off in April. I effectively ended the 2010 year with a negative $1500 balance. It just happened, it was not my intent. People end up on either side of the fence: They use up most or all of their allocation before full funding and get terminated because they have early uses of the funds, and then there are those that get terninated toward the end of the year, have a large balance because most of their expenses are at the end of the year, and they loose it all. Use it or lose it is a two way street, overfunding and the employee loses it and forfiets, underfund, and the employtee gains because it is a reverse forfiet. I don’t feel bad, and the only guilt I have have is that I didn’t make it the full $5K. The business knows the risks of offering this type of account, and I read that on average 14% is forfieted and this is a major windwall for the business. So who cares if the business loses sometimes, that is a business risk, and will usually hurt the business when they do large layoffs in the early part of the year.

  15. Marcy says:

    Can someone direct me to the IRS ruling that states that an employer cannot withhold any money that was paid out over and above the FSA Medical contributions at the time an employee would leave the company. For instance, an employee signs up to have $100 per pay for 26 pays withheld. The first of February, they turn a bill in for $2600 but have only contributed $200 so far. They leave the company on March 1st, so you have only been able to withhold $400 total of the $2600 that you have withheld. From what I am reading above, the employee leaves the company with $2200 in their pocket and the employer cannot withhold any of that out of the last paycheck. I can’t find anything that tells me that is an IRS ruling. Any help would be greatly appreciated.

  16. anne says:

    It is steeling pure and simple. Our CEO did it in his last week! We are a small non profit so we will eat the loss. He was also the one who put the limit on there. You chose your limit, if you chose to put too much a way that is a liability you take when you lose it.

    • Cooper says:

      If you think that is stealing, then what is it called if the roles were reversed and your small non profit was pocketing the extra money not used by the employee?

  17. Cindee says:

    Quick question – is there any kind of a loophole or flexibility for a service that is to be done that requires a prepayment before the service date? For example – IVF treatment – requires full fee up front before service begins. Is there any way to access an FSA account in this instance or does it have to be tied to a true date of service and not a future date?

  18. Kamassan says:


    I know that an old article, but would you be able to link the official FSA regulation that talks about this loophole?

  19. Lena says:

    Here is a link to the irs uniform coverage rule that states your employer cannot recoup the funds

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