IRS Modification of “Use-or-Lose” Rule For Health Flexible Spending Arrangements (FSAs)
The IRS has announced Notice 2013-71, which significantly changes the way that Healthcare Flexible Spending Accounts (HFSAs) will work in the future.
The announcement introduces a new concept, “carry-over”, to HFSAs. Plan sponsors may now (with appropriate and necessary amendments to their plan documentation) allow up to $500 of a participant’s HFSA funds to be carried over from one calendar year to the next. This is an exception to the previously long-standing Use-It-Or-Lose-It Rule.
The announcement goes on to clarify that the new Carry-Over option may NOT be used in combination with a Grace period. As a reminder, a grace period is an option to allow a year’s HFSA balance to be used to reimburse expenses actually incurred in the first 2-1/2 months of the following plan year. This should NOT be confused with a Run-Out period, which is a purely administrative period in the following plan year during which expenses incurred in the prior year can be reimbursed.
So this gives employers a choice: either continue with the grace period of a maximum 75 days during which participants may spend up to ALL of their remaining balance from the prior year, or adopt a carry-over provision which allows participants to carry-forward only up to $500 of their remaining balance from the prior year, but with the entire following year available to spend it. (This can effectively be viewed by employees as the ability to have a full $3,000 available in an HFSA in a single calendar year — $2,500 maximum current year deferral if permitted and elected, plus $500 of an unused prior year’s balance.)
Note also that due to the timing of the release and the time it takes for sponsors to amend plans, employers sponsoring HFSAs WITH grace periods in 2013 will NOT be able to change over to the Carry-Over provision as a substitute for the grace period until Calendar Year 2015.
More about this release can be found in the IRS Fact Sheet here.