FSA Forfeitures: What Employers Can Do With the Money (and Why You Shouldn't Want It)

When employees forfeit unused FSA dollars, the money doesn't just drop to your bottom line — the rules confine it to a few uses inside the plan, and every forfeited dollar represents an employee who overpaid taxes for nothing. Here's where the money can go, and why the better question is how to stop generating it.

Where Forfeited FSA Money Can Go

Health FSAs run on the use-it-or-lose-it rule: elections not spent by the deadline (plus any carryover or grace period you offer) are forfeited to the plan. Under the Section 125 rules, those "experience gains" can generally be used in a few ways:

Option	How it works	In practice
Offset plan administration costs	Forfeitures pay the FSA's reasonable admin fees	The most common use — reduces what you pay the administrator
Reduce future contributions	Forfeitures lower required salary reductions or fund an employer contribution for the next year	Effectively recycles the money into the plan
Return to participants uniformly	Distributed on a reasonable, uniform basis (e.g., per capita) — never based on individual forfeiture amounts	Rare; you can't give people back "their" money specifically

What you can't do: hand each forfeiting employee their own unspent balance back (that would unwind the tax treatment), or treat forfeitures as loosely available cash. Your plan document should say which route you use, and how forfeitures are handled is worth confirming with benefits counsel — especially if your plan is subject to ERISA, where plan-asset rules add constraints.

Why Forfeitures Are a Problem, Not a Windfall

On paper, forfeitures look like found money. Look closer:

Employees experience it as a loss — because it is one. An employee who forfeits $400 elected that money in good faith, had it withheld from every paycheck, and got nothing. They will remember at the next open enrollment, and the rational response is to under-elect or skip the FSA entirely. Forfeitures this year suppress participation next year.

Suppressed participation costs you real money. Every FSA dollar elected through your cafeteria plan escapes FICA — 7.65% saved on the employer side. When burned employees cut a $2,000 election to $500, you pay employer FICA on the $1,500 difference, every year, across everyone who got burned. The forfeiture you "kept" is routinely smaller than the payroll tax you now pay on the contributions it scared away.

It's a trust tax on the whole benefits program. "The company kept my FSA money" is the kind of sentence that travels. Benefits only drive retention when employees believe the design is on their side.

The goal isn't to maximize what you recover. It's to run a plan where there's almost nothing to recover.

Carryover vs. Grace Period

Your first lever is plan design. You can offer one of these (or neither — never both):

• Carryover: up to $680 of unused funds rolls into the next plan year. Protects the typical small remainder completely; amounts above $680 still forfeit.
• Grace period: up to 2.5 extra months to incur expenses against the old year's balance. Protects any amount, but only for those extra weeks — it extends the deadline rather than removing it.

Carryover fits workforces whose forfeitures are lots of small remainders (the common pattern). A grace period fits plans where a few people have large unspent balances and just need runway. Either one materially cuts forfeitures versus a hard December 31 cliff; offering neither is hard to defend. Employees' side of this — deadlines, eligible last-minute spending — is covered in our use-it-or-lose-it guide.

How to Actually Reduce Forfeitures

Plan design caps the damage; engagement prevents it.

1. Educate at election time, not just year-end. Most forfeitures start as bad estimates in October. Give employees a simple worksheet — recurring prescriptions, glasses, dental, planned procedures — so elections track reality. (The 2026 election limit is $3,400.)
2. Surface eligible expenses employees don't know about. The FSA-eligible universe is far bigger than most people realize. Hammock's AI expense discovery scans connected cards and accounts for eligible spend already happening — $3,000 found per employee on average. Money employees know they can spend is money they don't forfeit.
3. Make wellness spending eligible. With a Letter of Medical Necessity from a licensed provider, expenses like gym memberships, supplements, and massage become FSA-qualified. That transforms the year-end problem from "find medical expenses you don't have" to "use it on the wellness spending you were doing anyway."
4. Run a deliberate year-end push. A reminder cadence in the final 60 days — balance, deadline, concrete eligible ideas — moves the needle more than any plan-document footnote.

How Hammock Helps

Hammock administers FSAs with the engagement layer built in: LMN-backed wellness eligibility applied at card swipe, AI expense discovery that shows each employee what they can already claim, and education and enrollment sessions run by our team. Employees who can see $3,000 of eligible spending don't leave $400 on the table — and don't under-elect the following year.

For your team, that means forfeitures shrink toward zero the right way, participation rises (with employer FICA savings on every incremental dollar), and the plan reads as a benefit employees trust instead of a trap they've learned to avoid.

FAQ

Can an employer just keep forfeited FSA funds as profit?

Forfeitures stay within the plan's rules: offsetting reasonable administration costs, reducing future contributions, or being returned to participants on a uniform basis. They aren't a discretionary windfall, and treatment should match your plan document — confirm specifics with benefits counsel.

Can we return forfeited money to the specific employees who lost it?

No. Refunding individuals their own unspent elections would undo the pre-tax treatment. Any return to participants has to be uniform and reasonable — per capita, for example — not tied to who forfeited what.

Should we offer the carryover or the grace period?

You can offer one or neither, not both. Carryover (up to $680) suits the common pattern of many small unspent remainders; a grace period (up to 2.5 months) suits occasional large balances that need more time. Either beats a hard year-end cliff.

How big is the typical forfeiture problem?

It varies widely with plan design and education, which is exactly the point: forfeitures are mostly a function of how well employees estimate and how much they know is eligible. Plans that add expense discovery and wellness eligibility see balances get spent rather than stranded.

Do forfeitures affect our nondiscrimination testing?

Not directly, but the same disengagement that causes forfeitures also suppresses rank-and-file participation — which can tighten the key employee concentration test. Broad, confident participation helps both problems at once.

The Bottom Line

The rules give forfeited FSA money a few sanctioned homes — admin costs, future contributions, uniform return — but none of them is worth what forfeitures cost you in trust, participation, and FICA on the elections employees stop making. Pick a carryover or grace period, teach people to elect accurately, and give them enough eligible ways to spend that year-end scrambles disappear. A well-run FSA forfeits almost nothing, and that's the version that pays for itself.

Want an FSA employees actually spend down? Talk to our team.