Like long-hopeful sports fans whose patience is finally rewarded when their team wins the championship, advocates of change in the FSA “use-it-or-lose-it” rule have just won a huge victory.

In a move that had been expected, the U.S. Treasury Department and the IRS announced in Notice 2013-71 on October 31 that employers would be permitted to amend their health FSAs to allow workers to carry over into the immediately following plan year up to $500 of unused amounts remaining at the end of the plan year. Read more.

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FSA Carryover: At Long Last

Fri Nov 15, 2013

Like long-hopeful sports fans whose patience is finally rewarded when their team wins the championship, advocates of change in the FSA “use-it-or-lose-it” rule have just won a huge victory.

In a move that had been expected, the U.S. Treasury Department and the IRS announced in Notice 2013-71 on October 31 that employers would be permitted to amend their health FSAs to allow workers to carry over into the immediately following plan year up to $500 of unused amounts remaining at the end of the plan year.

Significantly, Treasury specified that the $500 carryover “does not affect the maximum amount of salary reduction contributions” that participants are permitted to make, currently $2500, under the provisions of the Affordable Care Act. Workers could therefore carry over $500 in unspent FSA funds, making a maximum of $3000 available in the following plan year.

Over a decade ago Ceridian was one of the first and strongest supporters of HR 1590, legislation introduced by Minnesota representative Jim Ramstad, to allow a $500 FSA carryover. Business organizations like the American Benefits Council, the Business Roundtable, the US Chamber of Commerce and the National Association of Manufacturers all lined up in support of sensible modification of the FSA “use-it-or-lose-it” rule.

The argument for change was obvious: the “use-it-or-lose-it” rule, in requiring forfeit of unused end-of-year FSA funds, discouraged tax-advantaged saving for ever-rising out-of-pocket medical costs.

The argument against the FSA “rollover,” as it came to be known, was that it would somehow become a back door to out-of-control deferred compensation, something expressly prohibited under the governing regulations for Internal Revenue Code Section 125 cafeteria plans. Because of the deferred comp barrier, the “use-it-or-lose-it” rule remained a fixture of FSA regulation for decades.

Why the Policy Change Now?

Somewhat surprisingly, credit for the $500 FSA carryover goes to the Affordable Care Act (ACA)—specifically the provision capping annual FSA elections at $2500, which became effective for FSA plans that began during 2013.

Treasury officials hinted at the coming change in IRS Notice 2012-40, which established rules for employers to implement the $2500 FSA statutory cap. The 2012 guidance suggested that the FSA annual limit in many ways obviated the concern that FSA carryover funds might accumulate over time as deferred compensation. Put simply, the ACA cap on annual FSA contributions made a strict “use-it-or-lose-it” rule unnecessary.

Effective Date

Perhaps to make the $500 carryover coincide with the 2013 statutory limit on FSA contributions, Treasury and IRS decided to allow employers to adopt the carryover provision to health FSAs “for the current Section 125 cafeteria plan year,” i.e., for 2013 FSA funds.

To be sure, adoption of the carryover option comes at a price—“a Section 125 cafeteria plan that incorporates a carryover provision may not also provide a grace period in the plan year to which unused amounts may be carried over.”

In other words, employers will decide which option to choose: carryover or grace period, making it unlikely that many employers who offer a grace period will opt for the FSA carryover in this first year—2013.

The October 31 Treasury/IRS carryover announcement is good news for consumers. No longer will an important option for tax-favored saving for health costs contain an end-of-year trap door. More and more working families will be able to leverage the tax savings of FSAs without fear of forfeiting hard-earned wages.

Looking back over some 12 years of support for practical modification of the FSA “use-it-or-lose-it” rule, Ceridian can identify with the perspective of Janet Trautwein, CEO of the National Association of Health Underwriters: “This is an issue that NAHU has been working on for many years and we are glad to see these common sense changes finally come to fruition.”