Flexible spending arrangements, or FSAs, have gained popularity among employers over the past fifteen years.  Today, approximately 14 million families participate in these benefit plans.  An FSA enables employees to set aside a pre-determined portion of their compensation on a pre-tax basis to pay for medical expenses that are not otherwise covered by a group health plan (e.g. deductibles, co-pays, dental/vision expenses and other non-covered items).  Until recently, there was no limit on how much money an employee could set aside for this purpose; however, the Affordable Care Act imposed an annual cap of $2500 on employee contributions beginning in 2013.

Although FSAs are an easy way for employees to reduce their taxes, there is a catch.  In order to allow pre-tax reimbursements of medical expenses, an FSA must include a "use-it-or-lose-it" rule.  In other words, any balance remaining in an employee's FSA account at the end of the coverage period (typically a calendar year) is forfeited and no longer available to the employee.  In 2005, the IRS loosened this rule by permitting plans to offer a 2 ½ month grace period for participants to spend down their balance from the prior year.  Notwithstanding the permitted grace period, the use-it-or-lose-it feature of FSAs often deters employees from participating or from making sufficient contributions.

On October 31, 2013, the U.S. Treasury Department announced another exception to the "use-it-or-lose-it" rule.  In Notice 2013-71, the Treasury Department authorized FSA plans to adopt a provision allowing employees to "carry over" up to $500 of their FSA balance into the following plan year.  FSA plans are not required to permit a carry over and may limit permitted carryovers to less than $500.  The amount carried over does not count toward the $2500 annual cap on employee contributions.

Interestingly, the new carryover rule is not available for FSA plans that continue to allow a 2 ½ month grace period.  Plan administrators wishing to take advantage of one of the "use-it-or-lose-it" exceptions must choose which of them will be more appealing to participants.  Plans that adopt the $500 carryover will need to be amended to reflect this change and to eliminate any grace period.  Once that is accomplished, benefits professionals will need to turn their attention to educating employees on the advantages of the new "use-it-or-lose-some of-it" rule.