For nearly 30 years, the “use-or-lose” rule has been the bedrock on which flexible spending arrangements (FSAs) have operated. It says that any amounts elected under an FSA for a given year must be used for expenses incurred during that year or forfeited. The IRS added a major fault line to the use-or-lose bedrock last week when it issued a genuine carryover rule.
Under the new carryover rule, employers may amend their cafeteria plans to allow carryover of up to $500 in unused health FSA amounts from one plan year to the next, for use at any time during that next plan year. While this additional flexibility is good news, there are some major caveats that may make a carryover provision unattractive to some employers. Issues include:
- A health FSA that has a carryover cannot also have a grace period (that’s the period of up to 2.5 months that a health FSA may provide after the end of a plan year during which participants can use up any year-end balances by incurring additional eligible expenses). Employers considering a carryover may wish to compare it to the grace period and decide which type of provision is more beneficial.
- As with the grace period, there will be complex interactions between the carryover and other requirements that potentially apply to health FSAs (e.g., COBRA, HIPAA and health reform coverage mandates). Details of those interactions have not yet been defined, so adopting a carryover may result in unanticipated compliance headaches. When considering a carryover, employers may wish to assess whether they are willing to go forward with these details undefined.
- Also like the grace period, the carryover is likely to affect individuals’ ability to contribute to a health savings account (HSA) during the carryover year, creating a complex set of issues to manage and communicate for employers that have or are implementing HSA-based plans. The IRS is likely to address those issues in future guidance, but employers sponsoring HSA-based plans should consider the potential complications.
- The reason for adopting a carryover or a grace period is to reduce participants’ risk of forfeitures. One consideration for employers is whether, on the whole, it is desirable to reduce the risk of forfeiture for health FSA participants.
- Although the carryover will reduce health FSA participants’ risk of forfeitures, employers may wish to assess whether that reduction will be sufficient to attract additional participants – particularly lower-paid participants – to the health FSA. Another consideration is whether the grace period is a better means of providing that reduced risk.