Flexible Spending Accounts Become More Flexible

Flexible Spending Accounts (FSAs) or Health FSAs for years have let employers provide pre-tax dollars through employee salary reductions or employer contributions to an FSA account that the employee can spend as he or she pleases for qualifying medical expenses.  The down side, especially if the FSA account were composed of salary reductions, was the “use-it-or-lose-it” rule.  This rule meant that unused money in an FSA account was forfeited at the end of the plan year.  Naturally, this led to end of year buying binges by employees who did not want to leave unused FSA money on the table.  Not only did this encourage potentially unnecessary spending but it also prevented employees from setting aside unused funds for a rainy day when a few extra dollars might go a long way to offsetting unexpected medical expenses during the next plan year.

Recognizing this problem, the IRS in 2005 allowed employers to include in their FSA plans a grace period of up to 2 ½ months after end of the previous plan year for employees to spend amounts left in their FSA account.  For the first time, Health FSAs, like Health Reimbursement Arrangements (HRAs) and Health Savings Accounts (HSAs), gave employers and employees the ability to moderate spending that was encouraged by the “use-it-or-lose-it” rule.

In late October of this year, the Treasury Department announced a new option that gives FSAs greater flexibility.  FSAs can now offer a $500 maximum rollover option that lets employees spend unused FSA account balances during the next plan year.  Not only does this defuse employee ill will caused by the forfeiture of unused balances, the new rule also lets the employee use the saved money after the expiration of the optional 2 ½ month grace period that was permitted under previous guidance.  Although the employer has to choose between the grace period option and the rollover option (a plan cannot have both options), it is clear that employees who are careful with their FSA money can look forward to managing those funds in a way that maximizes their usefulness, especially where medical expenses in a given plan year exceed the maximum amount (up to $2,500) that can be contributed to a Health FSA.

Overall, this small change is the kind of flexible thinking that makes a Flexible Spending Account a useful way to promote prudent use of healthcare resources.  For those employers who offer Health FSAs, it is a small but not insignificant way to make healthcare more affordable for everyone.

Authored By: Randall Weill, a partner in Preti Flaherty's Labor and Employment Group.