New $500 Carryover Rule for Health Flexible Spending Accounts (FSAs)

11/4/2013 Norbert F. Kugele

Thanks to new guidance from the IRS, employers who sponsor health flexible spending accounts (FSAs) can now allow employees to carry over as much as $500 of unspent health FSA funds every year—beginning with balances remaining at the end of current plan years.

One of the traditional rules governing FSAs has been the “use-or-lose” rule, which has required forfeiture of unspent FSA balances at the end of each year. Starting in 2005, the IRS began to allow FSAs to include a “grace period” that allows unspent amounts to be temporarily carried over into the next plan year.  While there is no limit to the amount that an employee can carry over into the grace period, that period can only last up to 2-1/2 months, at which time the employee forfeits any unspent carryover amounts. Now, as an alternative to the grace period, a health FSA may allow employees to carry over as much as $500 of unspent balances for use anytime during the following plan year. Employees can still choose to contribute up to $2,500 to their Health FSA, even if they carry over unused funds from the prior year.

To provide flexibility, the new rules allow an employer’s health FSA plan to specify any amount up to a maximum of $500 in unused funds for carryovers. Moreover, the carryover limit must be the same for all plan participants, and participants must still forfeit any amounts in excess of this limit at the end of the plan year. Also, this new carryover provision cannot be used in conjunction with the grace period rule; employers can choose to have a grace period or the $500 carryover feature, but not both.
 
If you are an employer who sponsors a health FSA plan and wish to offer the new carryover option to your employees, you should take the following steps:
 
  • Speak with the administrator of your health FSA program to determine whether the administrator can implement the carryover for 2013 unspent balances;
  • Amend your health FSA plan document to reflect the new carryover provision and, if applicable, to eliminate the grace period provision;
  • If you provide employees with the option of a high-deductible health plan with a health savings account (HSA), make sure that carryover amounts can end up in a limited purpose health FSA to ensure that employees who are switching to the high-deductible health plan will not be disqualified from contributing to an HSA; and
  • Issue a summary of material modifications to your employees to notify them of these beneficial changes.

If you currently use a grace period and are considering converting to the new $500 carryover rule, keep in mind that some employees may be planning to carry over more than $500 into the next plan year. Converting now could disrupt their plans for medical services in early 2014. To avoid this kind of disruption, you may want to delay the conversion until next year while you educate the employees on the change.

If you have any questions about the new modifications of the “use-or-lose” rules, please contact Norbert F. Kugele (616.752.2186 or nkugele@wnj.com) or any other member of the Warner Norcross & Judd Employee Benefits / Executive Compensation Practice Group.

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