IRS Issues Guidance on Health FSA Use-or-Lose Rule

November 01, 2013

The Internal Revenue Service (IRS) issued Notice 2013-71, which gives plan sponsors the option to modify the “use-or-lose” rule for health flexible spending arrangements (health FSAs) to allow a $500 carryover of unused health FSA funds into the following plan year, provided the health FSA does not also have a 2½ month grace period for incurring and submitting claims the following plan year. The Notice also clarifies the transition rule that allows non-calendar year cafeteria plan election changes to take into account Exchange coverage that begins in 2014. We summarize below the guidance that will be most relevant to plan sponsors. This change is one that the Business Group has sought and advocated for over the last decade. It will help more employees and their families benefit from health FSAs and put more money into health FSAs for out-of-pocket health care costs. We applaud the Treasury Department and IRS for this long-awaited change.

Modified Use-or-Lose Rule

Notice 2013-71 modifies the health FSA use-or-lose rule as follows:

A plan sponsor can (but is not required to) amend its cafeteria plan document to allow carryover into the following plan year of up to $500 of unused health FSA funds. The plan sponsor can also choose to set a lower maximum amount of carryover.
The same carryover limit must apply to all plan participants.
If a participant has more than $500 of unused health FSA funds at the end of a plan year (or more than the maximum carryover the plan allows), the participant forfeits the excess amount. Thus, for any given plan year, the carryover amount can never exceed $500.
For ease of administration, a plan can make reimbursements from current year health FSA amounts first and then from carryover amounts.
If a plan sponsor adopts the carryover, it cannot also provide a grace period of up to 2½ months to incur and reimburse expenses in the following plan year. However, the plan can still have a run-out period following the plan year during which plan participants can submit (and be reimbursed for) expenses from the prior plan year.

Plan Amendment Required

If a plan sponsor wishes to adopt the carryover, it must amend the plan document as follows:

If a plan sponsor wishes to allow carryover of 2013 plan year amounts, it must adopt a plan amendment accordingly on or before the last day of the plan year that begins in 2014. For example, a calendar year plan can allow carryover of unused 2013 health FSA funds into 2014 as long as it adopts a plan amendment by December 31, 2014. The plan sponsor must amend the plan to eliminate any grace period by December 31, 2013.
If a plan sponsor wishes to delay adopting the carryover until future plan years, it can do so. For all years after 2013, the plan sponsor must adopt the plan amendment before the last day of the plan year from which amounts are carried over, retroactive to the first day of that plan year. The plan sponsor also must amend the plan to eliminate any grace period by no later than the end of the plan year from which amounts may be carried over.
The plan must inform participants of the plan’s carryover provision, if any. The plan also should inform participants of the elimination of the plan’s grace period, if applicable.

Existing Health FSA Rules Still Apply

The Notice clarifies that existing health FSA rules still apply. For example:

The $2500 limit on health FSA salary reduction contributions still apples. Thus, for a given plan year, a health FSA participant can have up to $3000 available in his/her health FSA to reimburse health expenses, plus amounts that the plan sponsor contributes during the plan year (if any).
The uniform coverage rule requiring that the maximum amount of health FSA reimbursement be available throughout the plan year (minus reimbursements) still applies. For example, if a plan participant has $500 of carryover and elects $2500 of salary reduction for the plan year, the plan must make the full $3000 available for reimbursements at the beginning of the plan year.
Existing ERISA rules for plan documents still apply. Therefore, a plan sponsor adopting a health FSA carryover must amend SPDs, plan documents, and enrollment materials accordingly.

Transition Relief for Non-Calendar Year Cafeteria Plans

A participant who elected to salary reduce beginning in 2013 for health coverage through a non-calendar year cafeteria plan can prospectively revoke or change his/her election with respect to the health coverage once during the plan year without regard to whether the participant experienced a change in status event under the cafeteria plan rules; and
A participant who failed to make a salary reduction election beginning in 2013 for health coverage through a non-calendar year cafeteria plan (before the deadline for making elections) can make a prospective salary reduction election for health coverage on or after the first day of the plan year beginning in 2013 without regard to whether the participant experienced a change in status event under the cafeteria plan rules.

Notice 2013-71clarifies that a plan sponsor can be more (but not less) restrictive with the above transition relief. For example, the cafeteria plan can limit the above election changes to a certain period in the plan year, such as the first month of January 2014. To allow this relief, a plan sponsor must amend the relevant cafeteria plan document accordingly. The plan sponsor can adopt this amendment retroactively but must do so by December 31, 2014, effective retroactively to the first day of the plan year beginning in 2013.