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Thinking Through the IRS's New Carryover Rule for Health Flexible Spending Accounts

December 18, 2013

On October 31, 2013, the IRS modified a longstanding rule applicable to health flexible spending accounts (“FSAs”), commonly referred to as the “use it or lose it” rule, which requires that unused contributions remaining at the end of a plan year be forfeited.  The change, set out in Notice 2013-71, allows a cafeteria plan to provide for a carryover to the next plan year of up to $500 of any amount unused at the end of the year.  The carryover can be used to pay any FSA-eligible expenses for the entire plan year to which it is carried over.  For example, if an employee elects to contribute $2500 to his health FSA for 2015 and has $300 left over at the end of the 2014 plan year, and his plan provides for the carryover, he will have $2800 to use for qualified expenses in 2015.  The Notice also describes in which order expenses are reimbursed from carryover amounts vs. amounts elected for the current plan year, but that is beyond the scope of this post.

The Notice touts the carryover rule as adding flexibility to health FSAs in light of the Affordable Care Act’s cap on FSA elections to $2,500 per plan year, which was effective in 2013.  However, the timing of the notice, just before many companies began open enrollment for their 2014 plan year, left employers wondering when, and how, to proceed.  Following are some of the issues around the new carryover rule to think through as you consider whether to add it to your cafeteria plan:

  1. How does it fit into your current plan design?
    Many health FSAs include a grace period allowed by IRS, where an employee may use amounts remaining from a plan year to pay expenses incurred for qualified benefits up to March 15 (or two and a half months) following the end of that plan year.  Under the new guidance, a plan may not offer both a grace period and a carryover.  You will need to decide whether you want your plan to include the carryover, or the grace period, or neither, but the grace period and the carryover cannot be combined in a plan year.

  2. Which option- the new carryover rule or the grace period- best fits the needs of your participants?
    The carryover provision allows participants to use the carryover amount during the entire succeeding plan year, but it is limited to $500.  Conversely, the grace period only allows expenses to be reimbursed until March 15 of the following year (if your plan year is the calendar year), but the entire balance of the FSA account may be used until that date.  You should review the amount of forfeitures in your plan and the way in which employees use the grace period, if your plan has this feature, in order to decide which option is better for your plan.

  3. Can your plan service provider administer the carryover over, and when will they, and you, be ready to implement it?
    The Notice provides that employers may adopt the carryover provisions for plan years beginning in 2013 as long as they amend their plan documents before the last day of the plan year that begins in 2014 (by December 31, 2014 for calendar year plans).  We understand that some administrators have told their clients that they are prepared to implement the carryover rule, and have provided sample plan amendments to add the carryover to plans. Others are investigating the new feature.  If you are interested in the carryover provision, you should discuss with your TPA where they stand.

This is not a one-size-fits-all analysis, although these are issues that each employer should consider.  As always, you may contact us to discuss how the carryover rule might work in your plan.

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