Rules have changed regarding the "use it or lose it" rule for health care flexible spending accounts.
Employees who participate in FSA programs that do not include a grace period now are allowed to roll over up to $500 of unused funds at the end of the plan year. This change is effective immediately. However, in order to make this change, the FSA plan document will need to be amended.
The annual maximum salary reduction amount that applies to FSAs and is permitted by law will not be impacted by the rollover. This means that employees can roll over up to $500 and still place up to $2,500 from salary into an FSA for the plan year.
The change to the "use it or lose it" rule comes from the Treasury Department and the Internal Revenue Service. The goal of the change is to make FSAs more employee friendly and to provide employees with more flexibility.
Health FSAs are sponsored by employers, and the benefit plans allow employees to be reimbursed on a tax-favored basis for some medical expenses not covered by the employer's medical plan. Employees usually fund an FSA through a salary reduction agreement, and these contributions are deducted on a pre-tax and pre-FICA basis. Reimbursements from an FSA used for medical expenses are not taxed.
At the beginning of the plan year, employees decide how much money to contribute to an FSA. They take money from the account to pay for qualified medical expenses that are not covered by their employer's health plan — expenses that may include deductibles, co-pays, and medical products such as eyeglasses and hearing aids.
For 30 years, health FSAs have been subject to the "use it or lose it" rule. Instead of forfeiting the unused sum at the end of the plan year — a sum that's essentially an overestimation of how much an employee will spend on uncovered health expenses — employees now will be able to roll over up to $500 to use up in the next plan year. By allowing employees to carry over FSA money, employers are helping to cut back on wasteful FSA spending that occurs at the end of a plan year to avoid the "lose it" part of the "use it or lose it" rule. (For example, "use it or lose it" spending in the past may have included stocking up on over-the-counter medicine, bandages, or contact lens solution.)
What does this mean for employers? With the rule change, they now have three choices.
1.) Employers can allow employees to carry over up to $500 in a health FSA to spend in the following plan year on qualified medical expenses.
2.) Employers can give employees a two-and-a-half month grace period to spend any leftover FSA account money.
3.) Employers may decide not to include either of the above provisions in their FSA plan.
A health FSA program, however, cannot have both a grace period and a carryover.
If you have more questions about the rule change for FSAs or other innovative benefit strategies, please contact your HNI relationship manager.