Many employers offer employees a flexible spending account (FSA) benefit as part of their cafeteria plan (operated in accordance with Internal Revenue Code Section 125) that is part of their overall employee welfare benefits plan. FSAs allow employees to contribute up to $2500 per year on a pre-tax basis which can be used for approved types of medical expenses that are not otherwise covered by insurance.
One of the downsides of an FSA from the employee’s standpoint is the "use it or lose it" provision; employees must spend the entire amount contributed on qualifying expenses during a plan year, or forfeit that amount. The "use it or lose it" provision could cause employees to contribute an amount smaller than they otherwise would have because they are not comfortable in projecting the amount of expenses that they will incur during a year. Some 125 plans have tried to counter this concern by adopting a "grace period rule" which allows expenses incurred in the first two and one half months from the following year to be applied to FSA contributions for the previous year.
In IRS Notice 2013-71, the Internal Revenue Service announced a partial rescission of the "use it or lose it" rule. The Notice provides that $500 of unused FSA contributions can be carried over to the following year, without impacting the amount that can be contributed to the FSA for the following year. This change in the "use it or lose it" rule can be accomplished if: the plan sponsor amends the FSA to allow for this carryover; and, if the employer amends the FSA to eliminate the "grace period rule." In other words, the FSA could no longer offer participants the ability to use whatever amount is left over from the prior year in the first 75 days of the next year in exchange for a blanket carryover of $500. This will not impact the use of the "run-out" period, which provides that FSA-eligible expenses for a plan year do not have to be submitted by the end of that year—instead they will be paid in accordance with the "run-out" provision as long as the services were rendered during the plan year.
Should the 125 plan be amended?
An employer should analyze its 125 plan usage to determine the amount of forfeited contributions and the amount of subsequent year expenses that were paid through the "grace period" provision to determine if this amendment would make sense. Any change of this type would need to be communicated to employees, as it could impact both their contribution amounts and the timing of their purchases of medical services. The amendment can be made on a retroactive basis, to the beginning of the year in which the amendment is made; for example, an amendment in March, 2014 could apply to all transactions in the year that begins on January 1, 2014.
We would be pleased to discuss issues related to welfare plans. For more information on this topic, post a comment below or contact our Compensation & Benefits Advisory Services Group at 440-449-6800.
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