In a recent webinar, Jake Mattinson and Sarah Raaii discussed the basics of health savings accounts (HSAs) and health flexible spending accounts. They provided an overview of the various regulations surrounding HSA, such as eligibility requirements, high deductible health plans, and contributions and distributions, and cafeteria plans. Additionally, they analyzed the differences between HSAs and Health FSAs and HRAs.
The Internal Revenue Service and U.S. Departments of Health and Human Services and Labor recently issued guidance on the Affordable Care Act employer mandate and market reforms. Notice 2015-87 contains 26 FAQs that clarify the application of market reforms to health reimbursement arrangements and employer payment plans and the affordability of employer-sponsored health coverage, among other topics.
The Internal Revenue Service recently issued new guidance modifying the “use it or lose it” rule applicable to health flexible spending arrangements (FSAs) to allow carryover of certain unused health FSA amounts into the next plan year.
On October 31, 2013, the Internal Revenue Service (IRS) issued Notice 2013-71, which modifies the existing requirement that unused amounts in a health flexible spending arrangement (FSA) at the end of a plan year (or applicable grace period) must be forfeited. This new guidance permits an employer to amend its cafeteria plan, effective as early as the 2013 plan year, to allow up to $500 of unused amounts as of the end of the plan year to be carried forward for use in the following plan year. The tradeoff is that a health FSA cannot have both a grace period and a carryover feature; it is one or the other.
Carryover of Certain Unused Amounts Permitted
The “use it or lose it” rule applicable to health FSAs requires unused amounts remaining in a health FSA at the end of a plan year (or applicable grace period) to be forfeited. The new guidance now permits an employer to amend its plan to allow for up to $500 of unused amounts remaining in a health FSA at the end of a plan year to be carried forward to reimburse eligible expenses incurred in the next following plan year. While the employer can elect to allow less than $500 to be carried over into the next following plan year, the same carryover limit must apply to all plan participants. This $500 permitted carryover feature does not affect the $2,500 annual health FSA limit imposed by the Affordable Care Act. Thus, a participant with $500 remaining unused in his or her health FSA at the end of a plan year may be permitted to carryover the $500 into the next plan year, in addition to a maximum contribution of $2,500, for a potential total of $3,000 available reimbursement that next following plan year.
Under prior IRS guidance, health FSAs are permitted to include a two-month and 15-day grace period after the end of the plan year, during which a health FSA participant can incur eligible expenses and use the amounts contributed for the previous year to pay those expenses. The new guidance specifies that a plan that is amended to provide for the carryover of unused health FSA amounts into the following plan year cannot also have a grace period in place for that following plan year. Thus, an employer amending its plan to allow for carryover of unused health FSA amounts may also need to amend the plan to remove any existing grace period feature.
Deadline for Plan Amendments Allowing Carryover
Under the new guidance, an employer electing to allow for carryover of unused health FSA amounts must amend its plan to permit the carryover. This amendment must be adopted on or before the last day of the plan year from which amounts can be carried over; for example, for a 2014 calendar-year plan year effective date, the amendment must be adopted on or before December 31, 2014. The amendment can be effective retroactively to the first day of that plan year, provided the change is communicated to participants. The guidance contains a special transition rule that permits an employer wishing to make this change for a plan year that begins in 2013 to amend its plan at any time on or before the last day of the plan year that begins in 2014. If an employer must also amend its plan to remove any existing grace period, the amendment must be adopted no later than the end of the plan year from which amounts may be carried over.
Calculation of Carryover Amount
If a plan is amended to allow for carryover of unused amounts in a health FSA for a plan year, the amount that is to be carried over for a participant is determined after all expenses have been reimbursed for that plan year after the end of the plan’s run-out period. For example, if a plan has a run-out period that ends on March 31 of the following plan year, the amount carried over for a plan year is equal to the amount from that plan year remaining in the participant’s health FSA after March 31 (up to the carryover amount elected by the employer, but no more than $500). Any unused amount in excess of $500 (or, if lower, the carryover amount elected by the employer) is forfeited.
Under the uniform coverage rule, the maximum amount of reimbursement from the health FSA must be available for claims incurred at all times during the period of coverage. For plans amended to allow the carryover of unused health FSA amounts from a plan year into the next plan year, the uniform coverage rule may cause amounts to be incurred and claims to be submitted for the next plan year before the carryover amount for the first plan year is determined. For instance, a participant in a health FSA with a run-out period ending March 31 that allows for carryover of $500 may have $400 remaining in his or her health FSA as of December 31, and elect $2,500 to be contributed to his or her health FSA for the next plan year. If the participant incurs expenses of $2,700 in January of the next plan year and submits those expenses for reimbursement on January 31, the plan can use $200 of the amount remaining as of December 31 to reimburse the participant in full. However, this reduces the potential carryover amount and amounts left for reimbursement during the remainder of the run-out period to $200. The guidance contains examples for these situations.
Health Savings Accounts, and FSA and Health Reimbursement Arrangement Interaction
Although the topic is not addressed in this recent guidance, individuals who are covered by traditional, general-purpose health FSAs or health reimbursement arrangements (HRAs) are not eligible for health savings account (HSA) contributions. A participant with a general-purpose health FSA that contains a grace period, and who has a year-end balance, is ineligible for HSA contributions until the first calendar month after the grace period ends (e.g., April 2014, in the case of a January 1, 2013, through March 15, 2014, plan year, including grace period). The same is true for the participant’s spouse, if the spouse’s medical expenses are eligible for reimbursement from the general-purpose health FSA. It is likely that IRS rules regarding eligibility for HSA contributions will apply to the new carryover feature as well. Thus, if a participant is covered under a general purpose health FSA with a carryover feature, and amounts are remaining in the health FSA at the end of the plan year, the individual will be ineligible to make HSA contributions for the following plan year during which he or she is eligible to access carryover amounts. Further guidance from the IRS on this issue would be welcome.
The impact of the new carryover rule on limited-purpose health FSAs and HRAs (limited to reimbursement for dental, vision and post-deductible expenses) was not addressed in the guidance. Under prior IRS guidance, individuals covered by limited-purpose health FSAs and HRAs are eligible to make HSA contributions. Thus, if it is permissible for an employer that sponsors a limited-purpose health FSA and/or HRA to adopt a carryover feature, presumably participants who have limited-purpose health FSAs and HRAs with such features should be eligible to make HSA contributions while covered under such arrangements.
Employers now have a choice whether to adopt a carryover feature, a grace period feature or a traditional health FSA with no such feature. This is a matter of plan design and not employee choice. Employers should decide whether to amend their plans to allow for the permitted carryover of unused health FSA amounts, and timely amend plan documents and communicate to participants as necessary. Employers offering health FSAs containing a grace period and electing to allow carryover of unused health FSA amounts should amend their plans to remove the grace period as necessary and communicate the change to participants. In addition, employers that offer high-deductible health plans (HDHPs) with HSA features will need to assess how adoption of a health FSA carryover feature affects an individual or employer’s eligibility to make HSA contributions.
There are pros and cons for employers to consider in adopting the carryover feature and eliminating a grace-period feature. For example, participants with year-end balances greater than $500 may benefit from a grace period feature that contains no cap but has a shorter duration for incurring and submitting claims, while participants with year-end balances of $500 or less may benefit from having a longer duration to submit and incur claims. If an employer sponsors a HDHP with an HSA feature, consideration also must be given to how the grace period and carryover features affect an individual’s eligibility to make and receive HSA contributions. It may also be impractical for an employer to remove a grace period feature for the 2013 or 2014 plan year that has already been communicated to employees.