With the life-altering changes brought about by COVID-19, many employees are not able to incur services for dental, vision and other medical needs. Employees may have taken these anticipated medical expenses into account when making their Health Care Flexible Spending Account elections for the plan year.
The Health Care FSA rules require any unused amount remaining in a participant’s account at the end of a plan year be forfeited unless an exception applies. This is referred to as the “Use-it-or-Lose-it” rule. If Health Care FSA participants are not able to use the funds in their accounts because COVID-19 prevents them from incurring anticipated expenses, they will lose the money contributed for the plan year. As of the writing of this blog post, the IRS has not issued relief to address this issue.
There are two widely implemented exceptions to the Use-it-or-Lose-it rule: (1) carryovers of $500 or less and (b) grace periods.
A Health Care FSA may allow participants to carryover up to $500 of Health Care FSA contributions remaining at the end of a plan year to be used for qualified medical expenses incurred in the subsequent plan year. A carryover is an optional plan design and should be reflected in the plan document.
A Health Care FSA may be structured with a grace period which allows participants to access unused FSA contributions remaining in their accounts at the end of a plan year to reimburse expenses incurred during a grace period of up to 2-1/2 months after the end of the plan year. A grace period is an optional plan design and should be reflected in the plan document.
A Health Care FSA may have a carryover or a grace period, but not both.
Plan Design Changes
Some employers may want to implement a carryover provision to their existing Health Care FSA if they are concerned that participants will not be able to use their full FSA balance due to COVID-19 restrictions. Offering a carryover will require a plan amendment.
A Health Care FSA plan amendment to add a carryover must be adopted on or before the last day of the plan year from which amounts can be carried over. The date of the carryover can be effective retroactively to the first day of the plan year, provided participants are informed of the carryover provisions.
There are special considerations if the Health Care FSA includes a grace period for incurring claims. For any plan year, a Health Care FSA may have a carryover or a grace period, but not both.
Therefore, to offer a carryover, a Health Care FSA must be amended to eliminate the grace period provision before the end of the plan year from which amounts will be carried over. After the Health Care FSA is amended to remove the grace period, the carryover may be added. Of course, participants must be advised, in advance, of the change in plan provisions. While some participants may appreciate a $500 carryover, others may prefer incurring claims in a grace period since the dollar amount used in the grace period is not limited to $500.
An employer considering amending its plan to add a carryover and remove a grace period should consult with legal counsel. There could be ERISA or state laws, depending on the employer’s circumstances, that might restrict the ability to remove a grace period. It is possible that the IRS will recognize the problems employees will be facing with using Health Care FSA funds in light of COVID-19 and address matters in future guidance.