The Internal Revenue Service recently issued a notice (bit.ly/HQVmiW) modifying the longstanding "use-it-or-lose-it" rule for health flexible spending arrangements (FSAs). The new guidance permits employers to allow plan participants to carry over up to $500 of their unused health FSA balances remaining at the end of a plan year.
For nearly 30 years, employees eligible for health FSAs have been subject to the use-it-or-lose-it rule, meaning that any account balances remaining unused at the end of the year are forfeited.
In 2005, the IRS announced (1.usa.gov/1aYh0hH) that employers could amend their health FSA plans to allow for a "grace period" of two-and-a-half months after year-end. In other words, if an employer amends its plan to permit it, an employee who is unable to use the full amount contributed to the FSA during the year may carry over the unused balance for up to two-and-a-half months after the end of the plan year. For a calendar-year plan, for example, if an employee had an unused FSA balance as of December 31, 2013, the employee would have until March 15, 2014, to use the balance (assuming the employer's plan allows for such a grace period). Any amount unused after the grace period is forfeited.
The new guidance issued by the IRS now permits employers to allow employees to carry over up to $500 of the unused amounts left in their health FSAs for use any time in the next plan year (without the two-and-a-half-month time limit).
In addition, the existing option for employers to allow employees a two-and-a-half-month grace period after the end of the plan year remains in place. However, a health FSA cannot have both a carryover and a grace period: it can have one or the other or neither.