The IRS recently modified the “use-it-or-lose-it” rule for healthcare flexible spending accounts (FSAs) to permit a limited carryover of unspent funds from one plan year to the next.  Effective immediately, plan sponsors may amend their plans to provide that up to $500 of unused health FSA funds may be used in the immediately following plan year.  Plan sponsors are not required to adopt this optional provision and can choose the maximum carryover amount, as long as it doesn’t exceed $500. This carryover rule applies only to healthcare flexible spending accounts, not to dependent care flexible spending accounts.

An FSA may include this carryover feature only if the plan does not have a grace period.  Previously, the IRS expanded the FSA reimbursement rules to permit a plan to include a 2-1/2 month grace period after the end of the plan year during which an FSA participant could incur eligible medical expenses and receive reimbursement from amounts contributed during the previous year.  To take advantage of the FSA carryover feature, the plan must be amended to eliminate any grace period.  A plan may continue to have a “run-out” period in which a participant may file claims for medical expenses incurred during the plan year.

Carryover amounts do not affect the $2,500 (as adjusted for inflation) annual limit on salary reduction contributions to an FSA.

Plan sponsors who also offer a high deductible health plan with health savings account (HSA) contributions should be cautious when considering an FSA carryover provision.  Individuals who are covered by traditional, full-scope FSAs are not eligible for HSA contributions. Although not directly addressed by the IRS in this guidance, it is likely that IRS rules regarding HSA eligibility will apply to FSA funds carried over from the previous plan year.  Therefore, when an individual carries over an FSA account balance to a future plan year, he or she will be a participant in the FSA for the full new plan year, and become ineligible to make or receive HSA contributions for the entire plan year. 

Action Steps

To take advantage of this optional provision, plan sponsors must amend their cafeteria plans no later than the end of the plan year from which amounts may be carried over to provide for the carryover and to eliminate any grace period.  For 2013, there is a special transition rule which permits a carryover from the 2013 plan year to the 2014 plan year, provided the plan is amended to reflect the change no later than the last day of the 2014 plan year.  SPDs and other participant communications will also need to be updated.