Flexible Spending Accounts Get More Flexible With Rollover Option

If you often find yourself or your staff struggling to clear out  healthcare flexible spending accounts (FSAs), the federal government has offered you a reprieve.

Last week, the U.S. Treasury Department and the Internal Revenue Service announced that the government will relax  (opens in a new tab) the longstanding use-or-lose rule that applies to these accounts, which employees use to set aside pretax funds for healthcare expenses. The change will let employers allow workers to roll over a portion of unspent funds into the next year. More details below:

The changes explained: In a statement, the agencies announced that effective for the 2014 plan year, employers can opt to allow workers to carry over as much as $500 in unused FSA funds from year to year—funds that previously would have gone back to the employer. “Individuals can now participate in a health FSA without the risk of losing all of their unused contributions,” states the agencies’ fact sheet  (opens in a new tab) [PDF]. “This also cuts back on wasteful year-end FSA healthcare spending by limiting the risk of forfeiture, and in turn, reducing the incentive to spend down as year-end approaches in order to avoid losing unused funds.” According to the Society for Human Resource Management (SHRM), the changes have parameters that employers must consider  (opens in a new tab), including when such a rollover program could be implemented. Another big decision for employers: whether to exercise the rollover option rather than continue to give employees a grace period (in some cases up to two and a half months) to spend leftover FSA funds after the plan year ends. The new rules allow for a grace period or a rollover—but not both.

Associations back move: The change, announced on October 31, came after the IRS received plenty of feedback regarding the rule. A number of groups, including SHRM, the Small Business Council of America, and the Small Business Association of Michigan previously expressed concern over the use-it-or-lose-it policy. The rule is one of the biggest deterrents to workers using the accounts and often leads people to spend money on things they don’t need, the groups wrote in a joint letter last year  (opens in a new tab) [PDF]: “A ‘use it or lose it’ repeal would return consumerism to FSA plans, since participants would not spend indiscriminately at year-end in order not to forfeit their monies. Instead, they would spend wisely throughout the year, knowing that any unused money would be received in either taxable cash or as a retirement plan contribution, or alternatively be rolled over to the following year’s account.” The rule change is not the total repeal the letter requests but something of a middle ground.

The change doesn’t affect health savings accounts (HSAs), which have always allowed for such rollover.

(iStock/Thinkstock)