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November 5, 2013
The IRS has issued Notice 2013-71 which modified the §125 Health Flexible Spending Account (HFSA) ‘use-or-lose’ rule to permit up to $500 of unused HFSA account balance to be carried over to the following plan year. HFSAs can offer the current 2½ month grace period, or the new $500 carryover option, but not both. The carryover amount also does not count against the $2,500 salary reduction limit applicable to HFSAs.
The §125 rules prohibit participants from using contributions made to a HFSA for one plan year to provide a benefit in a subsequent plan year (commonly called the “use-or-lose” rule), and any unused contributions remaining at the end of the plan year are forfeited.
The §125 rules were subsequently altered to allow for a grace period for HFSAs, during which participants are permitted to use contribution amounts remaining from the previous year to pay expenses incurred for benefits during the period of up to two and a half months immediately following the end of the plan year.
Under these new IRS rules, plan sponsors are allowed to amend their plans to permit participants to carryover up to $500 of unused HFSA funds into the next plan year. The amount remaining at the end of the plan year (after any applicable run-out period) may be used to reimburse eligible expenses incurred during the entire plan year to which it is carried over.
Adoption of the carryover creates a number of administrative issues that must be addressed. Many employers use a third-party administrator (TPA) to administer their HFSA, so the plan sponsor may need to coordinate these issues with their vendor.
Individuals are ineligible for HSA contributions if they are covered by a “full” HFSA which reimburses eligible expenses prior to the individual meeting specific HSA deductible amounts. A participant who carries over HFSA amounts to a new plan year would make that individual ineligible for HSA contributions in the carryover year, even if they do not contribute anything to the HFSA in the new year. In this case, the individual would not be able to contribute to an HSA until after all HFSA funds are “spent down”. Employers could address this problem by designing an HFSA plan that automatically converts to a limited purpose HFSA for participants who have only rollover funds available, and who do not make a new HFSA election in the carryover plan year.
If the plan chooses to implement this new carryover rule, the §125 cafeteria plan documents must be amended accordingly (including elimination of the grace period provision, if applicable).
For plans beginning 1/1/2014, the amendment must be adopted on or before the last day of the plan year from which amounts may be carried over. The amendment may be effective retroactively to the first day of that plan year as long as participants are informed of the carryover provision.
For example, plan sponsors who wish to implement the carryover provision for a plan that begins 1/1/2014 will need to amend the plan no later than 12/31/2014.
Special rule for plan years beginning in 2013
A plan with a plan year that began in 2013 may be amended to adopt the carryover provision no later than the last day of the 2014 plan year. However, this special rule does not apply to plans with a grace period.
A plan with a grace period must be amended no later than the end of the plan year from which amounts may be carried over. Consequently, a plan with a grace period and a 1/1/2013 – 12/31/2013 plan year would need to be amended no later than 12/31/2013.
The plan’s ability to retroactively eliminate a grace period provision, previously adopted for the plan year, may be restricted by other non-Code (e.g. ERISA, etc.) rules. Consequently, any plan sponsor considering retroactive plan amendments which eliminate an existing grace period should consider the imapct carefully.
The addition of a carryover option to a HFSA may increase participation and reduce employee forfeitures. At the same time, the implementation of this provision will require some additional administration, and significant employee communication, on the part of the plan sponsor.
As always, should you have any questions, please contact your Parker, Smith & Feek Benefits Team.
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