IRS and Treasury Provide Carryover Flexibility in Health Care FSAs

This came as surprise to me. In Notice 2013-71, the IRS and Treasury provided another softer version of the Health Care Flexible Spending Account (FSA) use-it-or-lose-it (UIOLI) rule, allowing certain plans to be amended to allow for limited carryovers from year to year.

As people who deal with health care FSAs on a regular basis know, back in 2005, IRS and Treasury modified the then existing rules to allow a health care FSA to be amended to provide a "grace period" for UIOLI, extending 2 months and 15 days beyond the end of the plan year. So, in English, calendar year plans could allow participants in 2013, for example, to use their HSA deferrals up until March 15, 2014, without losing them. This was done to be consistent with the short-term deferral rules under Code Section 409A (although I'm not sure what the inherent connection should be between Sections 125 and 409A).

Now this. Under the new UIOLI rule, plan sponsors have a choice. Those that have never adopted the grace period rule (most have in my experience) may amend their plans to add the new $500 provision. Those that have the grace period provision may amend their plans to eliminate the grace period provision for a year and add the $500 rule.

What are the implications of this? While the Notice is effective immediately so that calendar year plans could be amended for the 2013 plan year, this blogger thinks that is generally not a good idea if the plan uses the grace period rule.

Why? Consider your employee Betty Badeyes. Betty, like the rest of us who stare at a computer screen more than we should, has long since not had 20/20 vision. She wears corrective lenses. And, she knows that she has an appointment in late January 2014 to have her eyes examined and probably get a new prescription. These are bona fide expenses for reimbursement under a health care FSA, and they are in excess of $500. Betty knows this. So, when she made her health care FSA election back in late 2012 for the 2013 plan year, she took into account that she would be spending about $1,000 in early 2014 that she could use under the grace period role.

If the plan sponsor, amends the plan to eliminate the grace period and implement the carryover rule for 2013, then Ms. Badeyes may have to change her name to Betty Badtemper as she will only be able to pay for about half of her eye care expenses with flex dollars. What's more is that unless she can find some other qualified medical expenses before the end of the plan year, Betty may be losing $500 under the UIOLI rule.

In summary, I think this is a good option that most plan sponsors should consider adopting. But, they should communicate the change before the beginning of the plan year that it will affect.