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Health flexible spending accounts (FSAs) are becoming more flexible. New federal guidance permits employers to allow workers to carry over unused amounts of up to $500 for expenses in the next year and still contribute up to $2,500 annually.

FSAs are voluntary account-based plans that enable millions of Americans to use pretax dollars to pay for eligible out-of-pocket health care expenses like prescription drugs, co-pays, and vision and dental costs. FSAs are often funded by employees, although companies can also make contributions. However, for nearly 3 decades, employees eligible for health FSAs have been subject to the "Use It or Lose It" rule, meaning that any account balances left at the end of the year were forfeited, usually to the employer.

Although an estimated 14 million American families participate in health FSAs, the "Use It or Lose It" rule has often been identified as the biggest reason why more eligible employees do not consider signing up for an FSA.

Grace Period or Limited Rollover—Not Both

On Oct. 31, 2013, the U.S. Treasury Department and Internal Revenue Service issued a notice and fact sheet announcing the change. According to the guidance:

  • Effective in plan year 2014, employers that offer FSA programs will have the option of allowing participants to roll over up to $500 of unused funds at the end of the plan year.
  • Effective immediately, employers that offer FSA programs that do not include a grace period will have the option of allowing workers to roll over up to $500 of unused funds at the end of the 2013 plan year.

Under current law, plan sponsors have the option of allowing employees a grace period of up to two and a half months after the year ends to use remaining funds for qualified FSA expenses.

Some plan sponsors may be eligible to take advantage of the option to adopt a carryover provision as early as plan year 2013, according to the notice. In addition, plan sponsors may continue to give employees a grace period. However, a health FSA cannot offer both a carryover and a grace period; it may provide just one of the options or neither.

In other words, employers can opt in for this year but would have to amend their plans, eliminating the grace period (if they offer one). Since open enrollment is already underway at many companies, amending plans and communicating these changes to employees could be challenging.

Eliminating the Rush to Spend

The change should “eliminate the wasteful spending that takes place each year as employees rush to consume their remaining FSA dollars due to the use-it-or-lose-it rule,” said Joe Jackson, CEO of benefits administration firm WageWorks, in a media release. “Employers, employees and their families now have more control and flexibility in managing their out-of-pocket health care expenses.”

The agencies’ action was in response to the public’s comments, which the Treasury and IRS solicited. “An overwhelming majority of feedback from individuals, employers and others requested that the use-or-lose rule for health FSAs be modified,” according to a Treasury statement. "Comments pointed to the difficulty for employees of predicting future needs for medical expenditures, the need to make FSAs accessible to employees of all income levels and the desire to minimize incentives for unnecessary spending at the end of the year."

HSAs Unchanged

The guidance makes no changes to health savings accounts (HSAs), which have always allowed participants to roll over all unspent funds from year to year. However, unlike an FSA, an HSA must be linked to a high-deductible health plan (in 2013 and 2014, deductible minimums were $1,250 for individuals and $2,500 for families). An insured individual may not have both an HSA and a health FSA but may hold an HSA and a “limited use” FSA restricted to covering dental and vision expenses.

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