The IRS has offered guidance (Notice 2013-71) modifying its "use it or lose it" rule to allow employers to amend their plans and allow employees to carry over up to $500 of unused money in a health flexible spending account (FSA) from one plan year to the next.
Under current proposed regulations for cafeteria plans under Section 125, a health FSA participant generally forfeits any money left in the FSA at the end of the plan year. Certain exceptions include the run-out period and the grace period. The run-out-period rule allows plan sponsors to specify a run-out period after the end of a plan year when participants can be reimbursed for medical costs incurred during the plan year that are submitted during the run-out period. Under the grace-period rule, the plan may allow an employee to use amounts remaining in the plan from the previous year to pay medical expenses incurred during the period up to two months and 15 days immediately following the end of the plan year. Currently, any amounts remaining in the plan after the optional run-out or grace period are forfeited.
Plan sponsors now have the option to amend their plans to allow up to $500 of unused funds in the health FSA to carry over to the next plan year. In general, the cafeteria plan amendment must be adopted on or before the last day of the plan year for which amounts may be carried over. The amendment may be retroactive to the first day of that plan year, provided that the plan operates in accordance with Notice 2013-71 and informs the participants of the carryover provision. For plan years that began in 2013, the plan may be amended any time on or before the last day of the plan year that begins in 2014.
A health FSA that is amended to include the carryover option is permitted to have a run-out period but not a grace period. If a plan has included a grace period and is being amended to add a carryover provision, the plan must also be amended to eliminate the grace-period provision by no later than the end of the plan year from which amounts may be carried over. The elimination of a grace-period provision may be subject to nontax legal constraints.
The Affordable Care Act amended Section 125 to limit the amount an employee may elect to contribute to a health FSA during a plan year. In 2013 and 2014, the limit is $2,500. The new carryover option does not affect this plan-year limitation. An employee may carry over to the subsequent year up to $500 and still elect to contribute up to $2,500 in that subsequent year.
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