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The New FSA Carryover Rule…Pros and Cons…

Originally posted November 05, 2013 by Josie Martinez on https://analytics.ubabenefits.com

First, Friday the 13th and then Halloween… Coincidence, or does the IRS have a peculiar sense of humor given the dates of its recent rulings? Regardless, there was breaking news on Oct. 31 when the IRS announced a change to the long-standing Health FSA “Use-It-or-Lose-It” rule. This important change allows Section 125 Health FSAs to be amended to allow up to $500 of unused amounts remaining at the end of the Health FSA plan year to be carried over to reimburse medical expenses incurred during the following plan year. The $500 carryover amendment may be adopted for the health FSA only; it is not available for Dependent Care FSAs. Also, the carryover of up to $500 does not affect the $2,500 maximum salary reduction that the participant is permitted to elect to a health FSA.

It is important to note that the new carryover rule can only be adopted by Health FSAs that do not also incorporate the “grace period rule” — the rule which has traditionally allowed expenses incurred within the two and one half months following the end of the plan year to draw down an account balance existing at the end of the prior plan year. The new carryover rule is an alternative to the current grace period rule. So, if an employer is deciding which rule to implement, keep in mind that there is no limit on the amount carried over in the grace period, but the money must be used within two and one half months – whereas the carryover is indefinite in duration, but limited to $500. The bottom line is that neither provision completely eliminates the chance of forfeiture.

A few important things that employers should keep in mind:

  1. The $500 carryover feature is not automatic; employers that wish to adopt the feature must amend the Health FSA plan to incorporate it.
  2. An employer may specify a lower maximum carryover limit or no carryover at all.
  3. Employers may adopt the carryover provision for the current or any future health FSA plan year. The amendment may be adopted during the plan year and be effective retroactive to the beginning of the plan year.
  4. Some FSA plan administrators may charge a fee to amend the health FSA to incorporate the carryover feature. Employers that elect to adopt the carryover rule should be aware that adopting the carryover provision may result in increased FSA administration costs. This is because the carryover provisions enable an employee to carryover account balances from year to year – and continue as a plan participant — even in the absence of additional salary reductions. Thus the employer may be required to pay monthly admin fees for non-electing FSA participants.

Finally, should an employer decide to amend their FSA to adopt the new carryover rule, it should be prepared to communicate the change to employees. Employee communications will be particularly important where the plan switches from the grace period to the carryover to ensure employees understand the limits of the carryover. Redistribution of health FSA SPDs may also be in order.