Update: the below content is applicable for 2021 to 2022 FSA carryovers. The maximum FSA carryover for 2023, 2024, and future years has reverted to 20% of the maximum annual FSA contribution amount permitted by the IRS.
Here is a noteworthy update for readers with a flexible spending account (FSA) – the Taxpayer Certainty and Disaster Tax Relief Act of 2020, signed into law by Congress on Dec. 27, 2020 as a COVID relief measure, will potentially give you some temporary flexibility on FSA carryover funds and how you use your funds in 2021 and 2022.
The IRS recently clarified the new FSA rule changes for 2021 and 2022:
- Provides flexibility for the carryover of unused amounts from the 2020 and 2021 plan years;
- Provides flexibility to extend the permissible period for incurring claims for plan years ending in 2020 and 2021;
- Provides flexibility to adopt a special rule regarding post-termination reimbursements from health FSAs;
- Provides flexibility for a special claims period and carryover rule for dependent care assistance programs when a dependent “ages out” during the COVID-19 public health emergency; and
- Allows certain mid-year election changes for health FSAs and dependent care assistance programs for plan years ending in 2021.
The most noteworthy change here is that the IRS is now allowing unused funds to carryover from the year they were contributed to the next year (2020 to 2021 and 2021 to 2022) to help with health care expenses during COVID. FSAs previously had a “use it or lose it” rule that dictated any unused FSA contributions were forfeited at the end of the year (though employers could allow up to 2.5 months grace period to use funds). A few years ago, a new FSA carryover rule was created that gave employers the ability to change their FSA plans to allow up to $550 (inflation adjusted 2021 limit) to be carried over from one year to the next. With this temporary change, the $550 rollover limitation is removed and the 2.5 month grace period is extended through the end of the year.
The maximum FSA contribution for 2021 is $2,750. Hypothetically, an FSA owner could carry over up to $2,750 in unused FSA funds contributed in 2021 to 2022, without any of those funds having to be forfeited.
The important thing here is your employer’s willingness to implement the changes. The new law makes it possible for employers to make these changes to FSA accounts, but it does not make it mandatory that they do so. In other words: it’s up to your employer to implement the rule changes now that they’ve been given permission. So check with your employer, and potentially prod them to implement the new rules. If your employer will not allow you to roll over more funds, the last thing you want to do is contribute more in 2021 and lose unspent funds at the end of the year, so confirming the changes have been implemented is important.
The rule changes also apply to dependent care assistance programs. They do not impact health savings accounts (HSAs), as HSAs already allow unlimited rollover funds, with no “use it or lose it” provision. For that reason, and their higher maximum contribution limits, HSAs are a favorite account type and HSA contributions are still preferable to FSA contributions if you are comparing HSAs versus FSAs for health care savings. Check out my best HSA account picks, if you have one and are interested in a possible upgrade.
Full IRS legalese on the changes can be viewed here, for those interested. Even though these changes were in light of COVID, any FSA rollover funds and spending can still be spent on any FSA-qualified medical expenses. Under the CARES Act legislation last year, Congress previously approved OTC medications and feminine hygiene menstrual care products as qualified medical expenses, joining a long list of HSA, HRA, and FSA-eligible qualified medical expenses, without an expiration date. This means that you can now use HSA, FSA, or HRA funds to use income-tax free contributions to pay for these items.