Employers Have Plenty to Assess with FSA Changes

From carryover limits to use-it-or-lose-it provisions, Congress has been tinkering.

By Steve Smith

Health Flexible Spending Accounts are popular with employers and employees alike. But being popular also means that Congress and the IRS like to tinker with the rules.

When it passed the Affordable Care Act in 2010, Congress said that Health FSAs were no longer permitted to reimburse participants for the cost of over-the-counter drugs that are purchased without a prescription. Earlier this year, Congress changed its mind. Under the CARES Act, Health FSAs are once again permitted to reimburse participants for the cost of over-the-counter drugs that are purchased without a prescription.

Not only that, but Health FSAs are now permitted to reimburse participants for the cost of menstrual-care products, including tampons, pads, and liners.

Both of these changes are already in effect.

The “use it or lose it” rule is one that almost nobody likes. Under this rule, if a participant contributes more to a Health FSA in a given year than what the participant has been reimbursed, the contributions remaining at the end of that year must be forfeited. Health FSAs can and do provide a run-out period for claims that were incurred in the previous year to be submitted for reimbursement. But once that run-out period is over, the rule requires leftover amounts to be forfeited.

The “use it or lose it” rule has several unintended side effects. Under the IRS cafeteria-plan regulations, participants are required to decide how much they will put in to a Health FSA before the beginning of a year. Once a new year has begun, that election generally cannot be changed. This discourages participants from putting money in. For example, parents may be discouraged from putting money in for a child’s braces if they are not sure when their child will be ready for braces.

For those participants who do still have money left near the end of the year, the rule encourages unnecessary spending. If the alternative is to forfeit money they have put in, participants may well decide that they should stock up on contact lenses and then hope that their prescription doesn’t change.

Health Flexible Spending Accounts are popular, but being popular also means that Congress and the IRS like to make refinements.

Neither Congress nor the IRS has acted, to this point, to repeal the “use it or lose it” rule, but, over the years, they have taken steps to relax its application. As a result, we now have two different (and mutually exclusive) options for avoiding forfeitures. 

The “grace period” option allows claims that have been incurred during the new year to be reimbursed with money that was put into the Health FSA during the year that just ended. There is no direct limit on the amount of the leftover dollars that may be used to reimburse new claims, but the new claims have to be incurred no later than March 15 of the new year (for a calendar year Health FSA). After that, it is too late and any leftover amounts must be forfeited.

The “carryover” option allows unused amounts to be carried over and added to whatever amount is being contributed for the new year. The combined amount can then be used to reimburse claims that are incurred anytime during the new year (and not just the first 2½ months of the new year). But the amount that can be carried over is limited.

For many years, the carryover limit was set at $500. At the time this limit was established, it was equal to 20 percent of the $2,500 limit that Congress had established for contributions to a Health FSA. Because the contributions limit was indexed for inflation, it has gradually increased. By 2020, the limit had increased to $2,750. However, the carryover limit continued to be set at only $500.

Earlier this year, however, the IRS determined that it was appropriate to set the carryover limit at 20 percent of the current dollar limit for Health FSA contributions. So, going forward, the carryover limit will be $550. And, whenever the Health FSA contributions limit increases in future years, the carryover limit will also increase.

This is mostly good news, but em-ployers who want to allow this may need to amend their plan documents. The old $500 limit was hard coded in many plan documents. Employers may also want to check with their Health FSA administrator to make sure that reimbursements for over-the-counter drugs and menstrual care products can be properly implemented. And they will need to communicate these changes to their employees before the new plan year begins. Employers Have Plenty to Assess with FSA Changes

About the author

Steve Smith is a partner at the Hinkle Law Firm, with local offices in Lenexa, Kan.
P | 316.267.2000
E | sssmith@hinklaw.com