Grace Period or $500 Rollover for FSA?

On October 31, 2013 the IRS amended the use-it-or-lose-it rule of Flexible Spending Accounts (Notice 2013-71). It was estimated that approximately 25% of all the participants in FSA plans were losing money due to electing more than their medical expenses totaled for the plan year. Nearly all the losses were under $500 per participant. Consequently, this had a negative impact on enrollment in the FSA benefit, because many employees were hesitant to utilize the benefit and risk losing any of their hard earned money.

Grace Period Rule

In 2005, the Treasury Department and the IRS modified the use-or-lose rule by adopting the grace period rule. Under the grace period rule, a 125 Cafeteria plan may permit an employee to use amounts remaining from the previous year to pay expenses incurred for certain qualified benefits during the period of up to two months and 15 days immediately following the end of the plan year (See notice 2005-42, 2005-1 C. B. 1204). Yet even with this addition, the public continued to argue for additional flexibility with respect to the operation of the use-it-or-lose-it rule. Their arguments included:

• Difficulty to predict their future medical expenditures to determine their election.
• Desirability of minimizing incentives for unnecessary spending at the end of the plan year, or grace period.
• Possibility that lower-and moderate-paid employees are more reluctant than others to participate because of aversion to even modest forfeitures of their salary reduction contributions.
• The opportunity to ease and potentially to simplify the administration of health FSAs.

In light of these comments, the Treasury Department and the IRS have determined that it is appropriate to modify the use-it-or-lose-it rule to permit the use of up to $500 of unused amounts in the health FSA in the immediately following plan year.

$500 Rollover

An employer, at their option, is now permitted to amend their 125 Cafeteria plan document to provide for the carryover to the immediately following plan year of up to $500 of any amount remaining unused as of the end of the plan year in a health FSA. The employer may choose to allow less than the $500 rollover, but not more than this amount.

Most employers offer a claim run out period (See Prop. Treas. Reg. $1.125-1(f)). This is a specific amount of time that is designated in the plan document where employees may gather the necessary documentation for claims incurred in the prior plan year and submit them for reimbursement. To enable those claims to pay out, the rollover money would not be moved into the new plan year until the run out period has expired. The rollover dollars that are moved into the current plan year will be available to the employee for the entire current plan year. Any unused amount remaining in an employee’s health FSA that exceeds the $500 limit will be forfeited. If the employee terminates, any unused amounts are also forfeited.

A plan adopting this carryover provision is not permitted to also provide a grace period with respect to the health FSAs. The employer must decide which policy would be most utilized by their employees. Here are examples of how both the grace period and $500 rollover can be a benefit to participants:

• Grace Period: If a service such as Lasik surgery is needed, and the grace period is offered, the employee can utilize two consecutive plan years to pay for this procedure. If the plan year is on a calendar schedule and the grace period is for two months, the employee may schedule the procedure for January or February. By doing this, both the prior plan year election as well as the current plan year election may be used to pay for the service. This way they have the maximum allowed to be elected (the IRS maximum is $2,550 with possible increases for cost of living) available to them. So a potential amount of $5,100.00 could be used to pay for this. Any unused prior plan year money, if not used during the grace period, is forfeited.
• $500 Rollover: An employee appreciates the flexibility and security of having an FSA, but estimates out of pocket costs for the year to be somewhere between $500-$1,000. The employee can make a conservative election and feel safe that $500 is protected from forfeiture from year to year.