Flexible Spending Account: Use It or Lose It!

When the fiscal year enters the last quarter, companies large and small anticipate and prepare for the inevitable wall of deadlines come year’s end. Since most cafeteria plans renew at the beginning of the new year, now is the time for employers to enroll in new plans. Meanwhile, employees must spend their existing FSA balances by the end of the year. With companies scrambling to meet enrollment deadlines while simultaneously monitoring employee expenses for compliance with IRS rules, costly compliance mistakes are very possible.

What is a Flexible Spending Account (FSA)?

A Flexible Spending Account (also known as a flexible spending arrangement) is a special account employees put money into that they can then use to cover certain out-of-pocket health care expenses. This money is effectively tax-free.

Flexible Spending Accounts (FSA) are a tremendous benefit employers can offer to their employees. Aside from the obvious tax benefits, the full amount employees elect is available to them on day one, even if they have yet to contribute. However, FSA’s aren’t without their risks for both employees and employers. Aside from the $2,550 maximum, employees will find their unspent money forfeited at year’s end (excluding a $500 rollover amount) a la the “use-it-or-lose-it” rule. Thankfully, the IRS has, in recent years, added a two-and-a-half-month grace period for employees to spend any unused funds. Employers will face considerable financial exposure as a result of the pre-funding requirement. They must deal with the administrative burden of not only day-to-day administration but also nondiscrimination testing to ensure the FSAs aren’t being used as a way to avoid taxes.

What is the Use-or-Lose It Rule, and How Does It Work?

The use it or lose it rule is a stipulation applied to Flexible Spending Accounts (FSAs), which mandates that any unused funds in an employee’s account at the end of the plan year will be forfeited. Essentially, if you don’t use the money you contributed to your FSA within the designated period, you lose it. This rule encourages employees to plan their medical expenses carefully and make use of the funds allocated for health-related expenditures within the specified timeframe.

Do FSAs Roll Over?

FSAs generally do not roll over. However, there are some exceptions to this rule, which include grace periods and rollover options that employers may offer. The grace period allows for an extension of time to use the previous year’s funds, typically up to 2.5 months into the new plan year. Alternatively, the rollover option permits a specified amount of unused funds (up to $610 for 2024) to be carried over to the next plan year. It’s important to note that these provisions are at the discretion of the employer and may vary.

Healthcare FSA Rollover Options

Employers can choose to offer a rollover option for healthcare FSAs, allowing employees to carry over a portion of their unused funds into the next plan year. The IRS determines the maximum rollover amount, and for 2024, this limit is $610. This rollover can provide employees with added flexibility and security, knowing that they won’t lose all their unspent funds. However, not all employers offer this option, so it’s essential to check with your specific plan administrator.

Limited-Purpose FSA Rollover Options

A Limited-Purpose FSA (LPFSA) is designed to cover eligible dental and vision expenses. Similar to healthcare FSAs, employers may also offer a rollover option for LPFSAs. The same IRS limit applies, allowing up to $610 of unused funds to be carried over to the next plan year. This feature provides an added benefit for employees who primarily need assistance with dental and vision expenses but find themselves with unused funds at the end of the year.

Dependent Care FSA Rollover Options

Dependent Care FSAs (DCFSAs) generally do not offer rollover options. These accounts are subject to the use-or-lose rule without the same flexibility provided to healthcare FSAs and LPFSAs. Funds allocated to a DCFSA must be used within the plan year, though some plans may offer a grace period extension. Employees must plan dependent care expenses accurately to avoid forfeiture of funds.

Grace Period vs. Rollover Example

To illustrate the difference between the grace period and the rollover option, consider an employee with a healthcare FSA who has $500 remaining at the end of the plan year.

Grace Period Example:
If the employer offers a 2.5-month grace period, the employee has until March 15th of the following year to use the remaining $500. Any expenses incurred during this period can be reimbursed from the previous year’s funds.

Rollover Example:
If the employer offers a rollover, the employee can carry over $500 (up to the $610 limit) into the next plan year. This amount is added to the new plan year’s contributions, providing additional flexibility in managing healthcare expenses.

Things to Consider Before Rolling Over Your FSA

Before opting to roll over your FSA funds, consider the following:

• Plan Offerings: Verify if your employer offers the rollover option and understand the specific rules and limits.
• Future Medical Expenses: Assess your anticipated medical expenses for the next year to determine if rolling over funds is beneficial.
• Contribution Limits: Remember that rollover amounts do not count against the new plan year’s contribution limit, providing an advantage if you expect higher medical costs.
• Tax Implications: Understand the tax implications and benefits associated with FSA contributions and rollovers.

Can Participants Change Their FSA Election During a Plan Year?

Typically, FSA elections are irrevocable for the plan year unless the participant experiences a qualifying life event, such as marriage, divorce, the birth of a child, or significant changes in employment status. These events may allow for mid-year changes to the FSA election, enabling adjustments to contributions based on new circumstances.

Does Use-or-Lose Also Apply to HSAs?

No, the use-or-lose rule does not apply to Health Savings Accounts (HSAs). Unlike FSAs, HSAs offer the advantage of rolling over all unused funds indefinitely, with no expiration date. Additionally, HSAs are portable, meaning the funds remain with the account holder even if they change employers or leave the workforce. This feature makes HSAs a more flexible and long-term savings option for healthcare expenses.

By understanding these aspects of FSAs and their use-or-lose rule, employees can make informed decisions about their healthcare spending and maximize the benefits of their accounts.

Outsourcing FSA Compliance to a PEO

Because the IRS can impose serious penalties for noncompliance, many companies opt to outsource FSA enrollment and administration to third parties, particularly PEOs. A Professional Employer Organization (PEO) is a third-party company that provides HR and HR-related services to client companies through a co-employment arrangement. There are many benefits to partnering with a PEO. First, PEOs can often leverage their size via “pooling” to secure better benefits at a lower price for their clients. Second, PEOs will then handle the administrative duties associated with these benefits, including enrollment and compliance, allowing client companies to focus on their core businesses.

Conclusion

Flex Spending Accounts must be used before the end of the calendar year, or it’s a wasted opportunity. Employers should be aware of FSA compliance and the fast-approaching deadline to renew or switch plans.

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