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IRS modifies “use-it-or-lose-it” rule

The IRS on October 31, 2013 issued a notice modifying the “use-it-or-lose-it” rule for Cafeteria
plan Health Flexible Spending Accounts (heath FSAs). For the first time, employees
participating in health FSAs will be allowed to carry over up to $500 of unused amounts
remaining at the end of a plan year.

How will the carryover work?
If an employee has an amount remaining in his or her health FSA at the end of the plan’s run-out
period, up to $500 may be “carried over” to the next plan year instead of being forfeited. (A
“run-out period” is the period of time after the end of a plan year that an employee has to file
claims for that plan year.) This carryover will be in addition to any amounts that the employee
may add to his or her account through payroll deductions for the next plan year.

For example, John makes an election to have $2,500 deducted pre-tax from his compensation for
Plan Year 1. The plan gives John three months after the end of Plan Year 1 to submit any
remaining claims for expenses that were incurred during Plan Year 1. At the end of this three
month period, John still has $600 remaining in his account for Plan Year 1. Up to $500 of this
amount may be carried over to pay claims incurred during Plan Year 2. In addition, John may
make an election for Plan Year 2 to have an additional $2,500 deducted pre-tax from his
compensation for Plan Year 2. John will therefore have $3,000 available in his health FSA for
Plan Year 2.

Which employers are permitted to make this change?
Only plans that do not provide a grace period may permit a carryover. A grace period is a period
of up to 2½ months after the end of a plan year in which an employee can incur claims and have
them paid from prior plan year funds. If a plan currently provides a grace period, the grace
period would have to be removed to adopt the new carryover provision. In other words, a plan
can have a grace period or a carryover, but not both.

Is this change mandatory?
No. Each employer can decide whether to adopt a carryover provision in their plan and what the
carryover limit will be, with a maximum of $500.

Is there a limit on how many times unused health FSA balances can be carried over?
No. If an account balance is not used during Plan Year 1, it can be carried over to Plan Year 2.
The amount that is not used during Plan Year 2 can then be carried over to Plan Year 3, and so

What do employers have to do to implement this change?
For plan years beginning in 2013, employers who have plans that do not provide for a grace period must notify Advantage Administrators as soon as possible that a carry over rule will be
used for balances remaining at the end of the 2013 plan year. We will then provide you with a
notice that you can give to your employees. We will also prepare a plan amendment that must
be executed prior to the end of the 2014 plan year (for calendar year plans, this amendment
deadline is December 31, 2014).

For plan years beginning after 2013, a plan amendment must be executed prior to the end of the
plan year for which the change is effective. For example, for the 2014 calendar year, an
amendment must be adopted by December 31, 2014. We strongly recommend that employees
be informed during their open enrollment period if the employer will adopt a carry over for that
plan year (and also if a grace period provision will be eliminated). We can provide sample
notices for you to distribute to your employees.

Because these are discretionary amendments, out standard amendment fees will apply.