Employees using flexible spending arrangements (FSAs) are now permitted to carry over up to $500 from the previous plan year and will not affect the maximum amount of salary reduction contributions — $2,500 — that can be made now that the U.S. Treasury Department and the Internal Revenue Service (IRS) have loosened rules on the rules on these health accounts.
This ends the 30-year-old “use-it-or-lose-it” policy, which forced plan participants to forfeit at the end of the plan year whatever unspent money they had set aside for medical expenses. The carryover allowance does not affect the maximum amount of salary reduction contributions that the participant is permitted, according to the IRS. The option serves as an alternative to the current grace period rule.
In 2005, the Treasury Department and IRS modified the “Use-or-Lose” rule by adopting a grace period that permitted an employee to use the remaining amounts from the previous year to pay expenses incurred for certain qualified benefits for up to two months and 15 days immediately following the end of the plan year. To use the new carryover option, a plan offering a health FSA must be amended to include the new provision and be adopted on or before the last day of the plan year from which amounts may be carried over, according to the IRS.
However, there is one caveat. If an employer chooses to incorporate the carryover into its plan, it may not also provide a grace period in the plan year to which unused amounts may be carried over. This means a plan may have the grace period or the $500 carryover but not both; it also may have neither.
The rule change is a response to public comments requested by the IRS and U.S. Treasury Department.
The feedback overwhelming requested modifications to the ‘use-it-or-lose-it rule, noting that it is difficult for employees to predict their future needs for medical expenses and lower- and moderately-paid employees are more reluctant than others to participate in these plans because of an aversion to even modest forfeitures of their salary reduction.
Employees also want to minimize unnecessary spending at the end of the year or grace period by stocking up on Band-Aids, over-the-counter medications and other FSA-eligible items.