Health flexible spending accounts, which allow employees to set aside pretax dollars for certain healthcare expenses, have been an important employee benefit for associations and other employers. Last year, the IRS changed the rules that apply to participants’ unused funds in FSA accounts, making the plans more flexible. But the change requires employers to make a choice and amend their plan to take advantage of the carryover rule.

Under the old use-or-lose rule, a participant forfeited any unused funds at the end of the plan year. Employers had the option of granting a grace period in which a participant could use up to the entire prior year’s contribution to pay for eligible expenses incurred in the next year for up to two months and 15 days into the new year.

The new rule provides another option. Employers may allow participants to carry over up to $500 in unused funds from one plan year to pay for eligible expenses incurred anytime in the following year. The employer may offer the grace period or the carryover, but not both. (Also, the carryover option applies only to health FSAs, not to dependent care accounts.)

The rule change is a mixed blessing. With the new carryover option, the participant has more time to use the funds (the entire following plan year), but the carryover amount is limited to $500. With the original grace period option, a participant has only two and a half months to incur additional expenses but may use the full amount of funds he or she didn’t use in the previous year (up to the $2,500 maximum yearly contribution).

These changes should not be confused with the run-out period on claims, in which expenses incurred during a plan year may be submitted for reimbursement early in the next year. This is still permitted.

An employer that wishes to switch from the grace period to the new carryover option must amend its plan in writing on or before the last day of the plan year from which amounts may be carried over. Employees must be notified of the change ahead of time.

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