Health Flexible Spending Arrangements Become More Flexible

BY: BRYDON M. DEWITT

New federal guidance makes health flexible spending arrangement (FSA) participation more attractive to employees.  IRS Notice 2013-17 provides a new exception to the FSA “use it or lose it rule.”

The Use it or Lose It Rule.  Under the “use it or lose it rule,” amounts contributed to an FSA for a plan year may not be used to reimburse health care expenses incurred in a later plan year.  Any amount remaining in a participant’s account at the end of the year is forfeited.  The risk of losing money in the account has discouraged employees from participating in FSAs.

New $500 Carry Over Relief.  Notice 2013-17, however, allows employers to amend their plans to permit participants to carry over up to $500 from one plan year to the next.  The carry over amount may be used to reimburse medical expenses incurred at any time during the subsequent plan year and is in addition to the $2,500 annual cap on FSA contributions.  For example, a participant who elects to contribute $2,500 to an FSA in 2014 and carries over $500 from 2013 would have $3,000 available for medical expense reimbursements in 2014.

Carry Over is an Alternative to the Grace Period.  The new carry over feature is an alternative to the existing 2½ month grace period.  Since 2005, plans have been allowed to use prior year account balances to reimburse medical expenses incurred up to 2½ months after the end of the prior plan year.  Plans that offer the grace period may not also provide the carry over.  An employer that wants to provide the carry over feature would need to amend its FSA plan document and employee communications to eliminate any grace period.

Amendment Deadline.  The carry over relief is available for plan years beginning in 2013.  Generally, a plan amendment implementing the carry over must be adopted by the end of the plan year from which amounts may be carried over.  The deadline for amending plans to adopt the carry over for 2013 plan years, however, is extended to the last day of the plan year beginning in 2014.

Practical Considerations.  Although the carry over is likely a better option for most participants, employers need to be careful about eliminating the grace period this year.  Employees made FSA elections for the 2013 plan year with the understanding that the 2½ month grace period is available.  In addition, participants in calendar year plans are making open enrollment decisions right now.  Eliminating the grace period for the current plan year and possibly the next plan year could be frustrating to employees.

Accordingly, employers that want to eliminate the grace period and adopt the carry over should look at the amounts that participants are likely to have remaining in their FSAs at the end of the current plan year.  If a significant number of participants are likely to have more than $500 remaining in their accounts, eliminating the grace period for the current plan year is probably not a good idea.  If, however, few or no participants are likely to have more than $500 in their accounts at the end of the current plan year, eliminating the grace period and adopting the carry over would be advantageous to employees.

Employers adopting the carry over should also be mindful of the fact that a participant’s carryover amount must first be reduced by any claims submitted for prior year expenses during the plan’s standard run-out period.