IRS Modifies Health FSA Rules to Permit Carryover of up to $500

Late last week the IRS released Notice 2013-71, modifying the health flexible spending account (“health FSA”) use-it-or-lose-it rule to allow participants to carry over up to $500 in unused health FSA funds. Although not unexpected (the Service has hinted at such a change a number of times over the past year), this new feature is welcome relief to participants and plan sponsors. Plan sponsors may adopt this optional amendment effective as early as the 2013 plan year.

Notice 2013-71 provides that a plan sponsor may, at its option, allow a participant to carry over up to $500 of unused health FSA funds to the immediately following plan year. Unused health FSA funds are those remaining at the end of the plan’s run-out period (if any), and do not count against the limit on participant salary reduction contributions. Accordingly, a participant could elect to contribute the full $2,500 (as indexed in future years) permitted by law and also carryover as much as $500.

An employer wishing to adopt this new carryover feature must amend its health FSA plan to provide for the carryover and must eliminate any grace period if the plan has one. The use of a carryover option does not, however, limit an employer’s ability to allow for a claims run-out period. (A grace period is a period of up to two and one-half months following the end of a plan year during which a participant may use amounts remaining from the prior year to cover expenses incurred during the current plan year, while a claims run-out period provides participants with some amount of time following the end of a plan year to submit claims for expenses incurred during that prior plan year.) Thus, for a plan allowing both the new carryover option and a claims run-out period, a participant’s unused health FSA funds from the prior plan year may be used to reimburse expenses incurred both (a) during the prior plan year and submitted during the plan’s run-out period, and (b) during the current plan year. Of course, health FSA funds that accrue during the current plan year may be used only to reimburse expenses incurred during the current plan year, except to the extent that the current plan year funds may later be carried over into the following plan year. For ease of administration, a plan may, but is not required to, use current year contributions to reimburse expenses prior to tapping into health FSA funds carried over from the prior year.

In general, a plan sponsor wishing to amend its plan to allow for carryover must adopt the amendment on or before the last day of the plan year from which amounts may be carried over, but for the 2013 plan year a plan sponsor wishing to allow carryover of 2013 balances into the 2014 plan year has until the last day of the 2014 plan year to adopt the amendment.

An employer considering whether to adopt the new carryover feature for the 2013 plan year should assess whether there remains sufficient time to properly inform participants of the new feature and the elimination of any grace period prior to the completion of open enrollment elections. If the employer is confident that employees would receive communications regarding the change in time to make their elections and plan for the elimination of any grace period, then the employer could amend its plan to allow for the carryover of 2013 balances. If, however, there is doubt about whether employees would receive notice in time to make elections and deal with the elimination of the grace period, then it may be better to wait for the 2014 plan year to allow for the carryover.