Good news may be on the horizon for those employees who find they are scrambling to buy an extra pair of glasses or rush to the dentist in order to spend the remaining funds in their Health Flexible Spending Account (HFSA or FSA) before the end of the plan year.  On October 31, 2013, the IRS released Notice 2013-71 which modifies the “Use-or-Lose” rule for Health FSAs.  Beginning immediately, employers may amend their Section 125 cafeteria plans to permit employees to carryover up to $500 in unused funds into the next plan year. 


By design, cafeteria plans may not provide for the deferral of compensation from one year to the next (e.g., a pre-tax contribution made in one year may not be used to purchase a benefit that will be provided in a subsequent year). This is what led to the unpopular use-or-lose rule requiring that claims for FSA reimbursements be made by the end of the plan year or they will be forfeited.   Most employers use the forfeited balances to offset the costs of administering their FSA plan(s).  In 2005, the IRS relaxed the use-or-lose rule by adopting a “Grace Period” rule.  Under the grace period rule, cafeteria plans may permit participants to use balances remaining in a health FSA to pay expenses incurred during a period of up to two months and 15 days immediately following the end of the plan year. 

Adopting the New Carryover Rules 

To utilize the new carryover option, employers must amend their Section 125 plan before the last day of the plan year for which amounts may be carried over.   The amendment may be made retroactively to the first day of that plan year, provided the employer informs participants of the carryover provision ahead of time.   With this Notice having been issued so late in the year, plan years beginning in 2013 may be amended to adopt the carryover provision at any time on or before the last day of the plan year that begins in 2014 (e.g., by December 31, 2014 for calendar year cafeteria plans). 

Employers should note that the new ruling prohibits cafeteria plans from incorporating both the carryover and the grace period provisions.   Therefore, those employers intending to add the new carryover option to their plan will need to eliminate the grace period option by the end of the plan year from which unused balances may be carried over. 

A Few Things to Keep In Mind

While not all of the following are new, employers who elect to adopt the carryover limit should be aware that: 

1)       The same carryover limits must apply to all plan participants;

2)       The carryover limit for any participant is $500 for a plan year (or a lower amount if specified in the plan);

3)       Any unused funds remaining in an employee’s health FSA in excess of $500 (or a lower amount if specified in the plan) will be forfeited;

4)       Any unused funds remaining in an employee’s health FSA as of termination of employment is forfeited, unless the employee elects COBRA continuation coverage with respect to the health FSA (if applicable);

5)       A Section 125 cafeteria plan is not permitted to allow unused funds in a health FSA to be cashed out or converted to any other taxable or nontaxable benefit;

6)       Unused funds in a health FSA may be used only to pay or reimburse for specific medical expenses (excluding health insurance, long-term care services or insurance, etc.) 


Employers are not required to add this relaxed carryover option to their health FSA plan and now have three options for addressing the use-or-lose rule:  1) adopt the new carryover rule; 2) use the grace period rule, or 3) allow neither the carryover nor the grace period rule.  An evaluation of the positives of adding a carryover option (i.e., increased participation by lower- and mid-salary range employees averse to participating for fear of losing unspent funds; additional flexibility for participants) with the negatives (i.e., additional costs associated with plan amendments and administrative fees) should be performed to determine if this is something that will benefit both the employees as well as the employer. 

For assistance in determining the advisability of adding a carryover option to a health FSA plan, it is recommended that employers seek guidance from their legal counsel.

Ann Kontner is a former senior human resources executive with vast experience in all facets of the HR field. She brings to S&J over 25 years of HR experience in corporate compliance, administrative management, staff development and executive leadership skills. She has worked for a wide range of employers including both public and privately held corporations, federal government contractors, and has experience working in both domestic and international markets.
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