Treasury Relaxes ‘Use or Lose’ Rule for Flexible Spending Accounts

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The Treasury Department and the Internal Revenue Service have loosened the “use it or lose it” rule for flexible spending arrangements for health care, allowing participants in health benefit plans to carry over up to $500 from their FSA from year to year.

The goal is to make health FSAs more consumer-friendly and provide added flexibility. As part of the Affordable Care Act, the federal government limited the amount of money that could be put into an FSA to $2,500 a year, and the new rule would encourage a greater number of workers, particularly low- and moderate-income taxpayers, to take advantage of FSAs without worrying that they will lose the money they put into the accounts.

However, it will be up to the employer to decide whether or not to offer this option to employees. Most employers have traditionally been able to hold onto any money left by employees in their FSA accounts.

“Across the administration, we are always looking for ways to provide added flexibility and commonsense solutions to how people pay for their health care,” said Treasury Secretary Jacob J. Lew in a statement Thursday. “Today’s announcement is a step forward for hardworking Americans who wisely plan for health care expenses for the coming year.”

Thursday’s action comes in response to to public comments requested by the Treasury Department and the IRS.  An overwhelming majority of feedback from individuals, employers and others asked that the use-or-lose rule for health FSAs be modified. Comments pointed to the difficulty for employees of predicting their future needs for medical expenditures, the need to make FSAs accessible to employees of all income levels, and the desire to minimize incentives for unnecessary spending at the end of the year. A senior Treasury official told reporters on a conference call that there weren’t any comments from employers indicating that they wanted to keep unused money left by employees in their FSA accounts.

For nearly 30 years, employees eligible for health FSAs have been subject to the use-or-lose rule, meaning that any account balances remaining unused at the end of the year are forfeited. An estimated 14 million families participate in health FSAs. Under current law, plan sponsors have the option of allowing employees a grace period permitting them to use amounts that remain unused at the end of a year to pay qualified FSA expenses incurred for up to two and a half months following year-end. 

Thursday’s guidance permits employers to now allow employees to carry over up to $500 of the unused amounts left in their health FSAs for expenses in the next year. Some plan sponsors may be eligible to take advantage of the option to adopt a carryover provision as early as plan year 2013. In addition, the existing option for plan sponsors to allow employees a grace period after the end of the plan year remains in place. However, a health FSA cannot have both a carryover and a grace period: it can have one or the other or neither.

The senior Treasury official noted that under longstanding rules, if somebody leaves the job and if their employment terminates, they forfeit at that point any unused amounts in their FSA. Asked what happens if an employee has more than $500 left over in their FSA in two successive years, he responded that they would still only be able to carry over $500 to the following year.

But he believes the changes will still help workers, particularly those in the low- and moderate-income brackets who are concerned about losing even a few hundred dollars that might be less of a concern for those with higher incomes. “This is something that may well encourage more people to contribute to these plans,” he said.

The modification does not affect another provision of the Affordable Care Act restricting the use of health spending accounts, or HSAs, for buying over-the-counter drugs and other health care items without a doctor’s prescription.

The senior Treasury official said there was no revenue estimate for the modification in terms of affecting the cost of the Affordable Care Act as the $2,500 limitation that it is modifying had not been codified into statute.

Notice 2013-71 explains the modification in greater detail. There is also a fact sheet on the modified rules from the Treasury Department.

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