If you've included a health flexible spending account (FSA) in your company's employee benefit plan, you’re probably familiar with the "use it or lose it" rule. For many years, plan participants had to spend their account balances by the end of the year or forfeit the funds back to the plan. According to the Society for Human Resource Management, the use-it-or-lose-it rule has been cited as a major deterrent for those considering whether to sign up for a health FSA.
That’s why the IRS in 2005 issued guidance allowing the option for health care FSAs to provide participants with a 2.5 month grace period after the end of a plan year. In late 2013 the IRS further modified the use-or-lose rule for health FSA plans by allowing an option for participants to carry over a portion of their unused funds. Now employers have two options:
- Allow employees to carry over up to $500 of unused health FSA money at the end of the year to apply to the next plan year (remaining funds in excess of $500 are still forfeited to the plan); or
- Elect a grace period to permit employees to use their unused account balances to pay for medical costs incurred during the first 2.5 months of the next plan year (up to March 15 for calendar year plans) before they must forfeit the money.
Both options are intended to reduce "wasteful" end-of-year spending as employees hurry to spend their FSA accounts rather than lose the money. Employers are not required to offer either option, in which case the traditional “use it or lose it” rule will still apply. But if you do choose to offer one of these options to your workforce, you must pick only one, as employers cannot allow employees both a carryover and a grace period for their health FSA.
What is an FSA?
Health FSAs allow employees to use pretax dollars to pay for eligible out-of-pocket health care expenses such as co-pays, prescription medications, vision care, and dental work, for themselves, their spouse, and eligible dependents. These account-based plans are voluntary and funded by employees, although employers can also make contributions.
Considerations for Employers and Employees
The health FSA revisions mean less unnecessary year-end spending by employees and more FICA savings if more employees sign up for a health FSA plan. However, fewer forfeitures or unused FSA balances might mean less money to offset FSA administrative costs and additional administrative work in tracking FSA funds if the $500 carryover option is chosen.
For employees, the new rules mean less concern about spending FSA funds before year-end and the benefit of having funds available for the next plan year — either up to $500 for the entire year or a balance for use during the grace period.
When Do You Need to Choose?
If you wish to offer one of these options for your health FSA plan, you should make a decision as soon as possible, ideally prior to open enrollment for the following year. This will allow employees to make their plan elections accordingly. If you offer one of these options, you need to amend your plan (if you already have one) and communicate any changes to participants.