A few months back, we went over the basics on flexible spending accounts (FSAs). For those who do not have access to an HSA (which requires being paired with a HDHP in order to be able to contribute new funds) – FSAs are an excellent alternative.
When used properly, FSAs allow you to set aside pre-tax contributions that can be used – tax free – for medical expenses ranging from co-pays, to prescriptions, eyeglasses and more.
FSA Use-It-or-Lose-It & Carryover Rule
But, there’s always been one big downside to FSAs – you couldn’t carry over funds from one year to the next. You actually lose them altogether. For example, if you contributed $1,000 to an FSA in this year and spent $700 of it during the year, you’d lose the other $300 that went unspent.
This was dis-affectionately dubbed the “use-or-lose-it” rule. And the funds you lose actually end up getting eaten up by your employer in to an FSA slush fund of sorts. Bummer, right? The “use-or-lose-it” rule has dissuaded many people from contributing to FSAs altogether. One thing worse than medical expenses (which are awful in their own right) is seeing money you’ve earned and set aside for medical expenses taken away by your employer because you couldn’t spend it in time.
To encourage more participation, a few years ago, the IRS began allowing a grace period of up to 2 months and 15 days in which funds from the previous year could be spent in the following year.
Still, people were turned off.
Back in that basics article, I mentioned that the IRS was re-evaluating the “use it or lose it” rule. And it turns out that they have since made a ruling on it. They didn’t get rid of it altogether, unfortunately, but that was an unrealistic dream (lots of tax revenue potentially lost).
Now, employer plans are permitted to allow plan participants to carry over up to $550 (inflation adjusted each year) of their unused health FSA balances remaining at the end of a plan year in to the next year.
This means that if, for example, you contributed $1,000 in 2020 and spent $450 during 2020 on qualified medical expenses, the unspent $550 could roll over in to 2021, if your employer allows it.
Update: as a COVID-relief measure, Congress and the IRS approved new FSA rule changes for 2021 and 2022 that allow up to the maximum FSA contribution to be carried over into the subsequent year (2020 contributions to 2021 and 2021 to 2022).
FSA Carryover Rule Q & A
This is a big change. I’m expecting a lot of questions on this new rule, because it is not the most intuitive, yet it suddenly makes FSAs much more appealing to a lot of people – so I researched some expected questions and found answers:
Q: Is my employer required to offer the FSA carryover?
A: No. Employers are not required to adopt this rule, just like they were not required to adopt the grace period rule. In other words, while it was not legal for employers to create their own carry-over rule prior to now, it is now allowed, but not required.
Q: What year does this take effect?
A: This is already in effect. During open enrollment season, check with your HR department if you’re wondering about this.
Q: Can a FSA have both a grace period and the carryover?
A: No. A flexible spending account cannot have both a carryover and a grace period: it can have one or the other or neither, at the employer’s discretion.
Q: Do carried over funds count against the maximum FSA contribution for that year?
A: The FSA carryover also does not impact the indexed maximum FSA contribution. In other words, you could roll over the carryover and still contribute the indexed maximum for that year (maximums per employer plan do vary from the IRS maximum occasionally).
Q: Will the carryover amount carry over more than one year? In other words, if I have $550 roll over to 2021, spend $0 in 2021, will the amount roll over to 2022? 2023?
A: Per the IRS guidance, this is allowed. However, your plan might have differing rules.
FSA Carryover Discussion:
- Will this new rule ease your concerns on contributing to an FSA? Or maybe even contribute for the first time?
- How much will you be contributing to your FSA before/after the rollover rule (if used by your employer)?