Alert: IRS Modifies "Use It or Lose It" Rule for Health Flexible Spending Accounts

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November 7, 2013

On October 31, 2013, the Internal Revenue Service, in IRS Notice 2013-71, modified the “use it or lose it” rule that applies to health flexible spending accounts. While this change may appear at first to be nothing but good news, an employer must look closely at the new rule to determine if it makes sense for its plan.

Under the new rule, an employer’s health flexible spending account may allow up to $500 of a participant’s health FSA to be carried over into the next year. A plan may allow a carryover limit of less than $500, or may not allow any carryover at all. But if an employer wants to add a carryover feature to its health FSA, there are a few rules that must be followed, including:

  • the carryover cannot exceed $500;
  • the carryover only applies to a health FSA (i.e., not to a dependent care FSA);
  • the carryover does not reduce the maximum amount that generally applies to health FSAs ($2,500 for 2013 and 2014);
  • a carryover may not be permitted with a grace period; a plan may have a carryover feature, or a grace period, but not both;
  • amounts carried over must be used in the subsequent plan year, or forfeited by the end of the subsequent year;
  • a plan must be amended to allow the carryover before the end of the first year in which the carryover will be allowed, except an employer can administer the plan with a carryover for the 2013 plan year without having to formally amend the plan until 2014; and
  • a carryover in a general-purpose FSA may result in an individual being ineligible to contribute to a health savings account for the entire year that the amounts are carried over to.

The new carryover feature will certainly be welcome news to many employers. However, considering that the IRS announcement did not occur until most employers were in, or near, their annual enrollment period, it may make sense for an employer to wait until 2014 to implement the new feature, especially if the employer’s plan already has a grace period, which would need to be eliminated if the carryover feature is adopted. Nonetheless, it is a new feature that every employer with a health FSA should at least consider.