Use-It-or-Lose-It Rule Modified for Health Care FSAs

The IRS has issued IRS Notice 2013-71, allowing limited carry-over of amounts in employees’ flex plan accounts to the following plan year. Under the guidance employers may permit participants to carry over up to $500 of unused amounts in their health care flexible spending account into the next plan year.

Background

Effective for 2013, the maximum annual pre-tax contributions participants can make to a health care flexible spending account is $2,500. In conjunction with imposing this new limit the IRS asked for comments on whether the “use-it-or-lose-it” rule should be modified. Under the “use it or lose it” rule participants lose any unused amounts left in their health care flexible spending account after the end of the year (including any grace period). Plans may currently offer a grace period, which, if adopted for a plan, extends for up to 2-1/2 months the period during which medical expenses may be incurred and applied against any amounts remaining from the previous year in participants’ health care flexible spending accounts before the remaining amount is forfeited.

New Guidance

IRS Notice 2013-71 allows up to $500 to be carried over into the next plan year to be used to pay for qualifying medical expenses incurred in the next year, provided the plan does not utilize a grace period. The amount carried over will not be counted toward the participant’s $2,500 limit on pre-tax contributions for the next plan year. The carried over amount may be used to pay or reimburse medical expenses incurred during the entire plan year to which it is carried over, not just the first 2-1/2 months as under the current grace period allowance.

The change is effective for amounts contributed during the 2013 plan year and is optional for plans. In general, to adopt this change a plan must be amended before the end of the plan year in which the contributions to be carried over are made. However, if an employer wants to adopt the new carryover rule for 2013, it has until the end of the 2014 plan year to amend its plan.

Employers will need to weigh the value of allowing the limited carryover of unused contributions to be used over the following plan year with the shorter grace period for unlimited unused contributions. Employers will also need to take into account employee expectations where flex plan elections are already in place.