News

IRS Eases Rules for Health FSAs

21 January 2014

If you offer health flexible spending accounts (FSAs) as part of your company’s benefits plan, you’ve probably dealt with panicked employees who realize in January that they still have money in their FSAs—money they won’t get back. You may have even had this experience as an employee yourself.

“The IRS recently announced changes modifying the ‘use-it-or-lose-it’ rule that applies to health FSAs. This is good news, and I’ll tell you why—plan sponsors now have the option of allowing employees who participate in health FSAs to carry over up to $500 of unused funds to the following plan year.”

—Eric Rigby, Principal and financial expert at Rigby Financial Group

What Does This Mean for You?

If you’re an employer who offers health FSAs, consider whether taking advantage of this new carryover policy would be a good fit for your company from a financial or employee relations standpoint. If so, amend your plans accordingly after consulting with a benefits specialist.

If you participate in an FSA as an employee and your employer adopts these changes, you may not need to rush out and spend your remaining balance before the end of your plan year.

Rigby Financial Group offers extensive services in the areas of human resources and benefits consulting. Read on for more info, or contact us so that we can connect you with one of our experts to review your plan or answer any questions you may have about how these IRS changes may affect you as an employer or an employee.

Background

Health FSAs are tax-advantaged employer-provided benefit plans that employees can use to pay for qualifying medical expenses. While generally funded through voluntary employee salary reductions, employers can contribute as well. Prior to the start of a plan year, employees decide how much to contribute to their health FSA. For 2014, the maximum annual employee contribution to a health FSA that is part of a cafeteria plan is $2,500.

Contributions to the plan are excluded from income for federal income tax purposes, as are any reimbursements made from the plan for qualified medical expenses, including co-payments, deductibles, and dental and vision care expenses.

Employees forfeit any funds left unspent in their health FSA at the end of the plan year—this is commonly referred to as the “use-it-or-lose-it” rule. However, plan sponsors do have the option of providing for a grace period of up to 2½ additional months after the end of the plan year (e.g., a calendar year plan might cover expenses incurred through March 15).

What are the New Rules?

In Notice 2013-71, the IRS modified the “use-it-or-lose-it” rule that applies to health
FSAs as follows:

Employers can now amend their plans to allow participants to carry over up to $500 of unused health FSA funds at the end of a plan year. Carryovers do not count against the $2,500 limit in the next plan year.

Employers can allow participants a grace period (up to 2½ months after the end of the plan year), or the ability to carry over unused funds—but not both. However, a plan doesn’t have to allow either the grace period or the carryover option.

To adopt the carryover option, employers must amend their plans on or before the last day of the plan year from which amounts may be carried over. A plan can be retroactive to the first day of the plan year, provided the employer meets certain requirements, including participant notification.

Special rules apply to plan years beginning in 2013: Employers can amend these plans to retroactively adopt the carryover provision at any time on or before the last day of the plan year that begins in 2014.

A Word of Caution

A health FSA plan can’t have both a grace period and a carryover option, so employers will have to amend plans to remove existing grace period features in order to add carryovers. Plan sponsors should consult carefully with a benefit specialist before taking any action, however, as eliminating an existing grace period feature raises potential issues relating to the Employee Retirement Income Security Act of 1974 (ERISA). In fact, IRS Notice 2013-71 states, “the ability to eliminate a grace period provision previously adopted for the plan year in which the amendment is adopted may be subject to non-Code legal constraints.”

Disclaimer

The information presented here is not specific to any individual’s personal circumstances.

These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.