November 12, 2013 - Limited Carryover For Certain Health FSAs
New Carryover Opportunity
The IRS released guidance on October 31, 2013, (available at http://www.irs.gov/pub/irs-drop/n-13-71.pdf) announcing that, effective immediately (i.e., as soon as the current plan year), certain health flexible spending accounts (health FSAs) may allow a limited carryover of account balances from one plan year to the next. Employers may, but are not required to, amend their health FSAs to permit a carryover.
Basic Requirements. The carryover feature must satisfy the following requirements:
Maximum Amount. The amount that may be carried over is capped at $500 per year. The employer can choose a lower cap. Whether to permit the carryover and the amount of the carryover are plan design issues for the employer that sponsors the health FSA.
No Grace Period Allowed. The new carryover is mutually exclusive with the grace period. A health FSA may include the carryover feature only if the plan does not have a grace period that covers the same plan year end. A health FSA that currently includes a grace period would need to eliminate the grace period in order to adopt the carryover feature. For instance, if the plan currently allows a grace period following the end of the 2014 plan year, then the plan would need to be amended to eliminate the grace period that follows the 2014 plan year in order to implement the carryover feature from the 2014 plan year to the 2015 plan year. Note: The grace period from the 2013 plan year into the 2014 plan year could still operate.
Additional Considerations. Being able to satisfy the requirements is just the beginning of the analysis. Other, already existing rules must still be followed.
Interaction with Cap on Salary Reduction Contributions. Carried over balances do not affect the amount of salary reduction contributions that may be made in the new plan year. In other words, the amount of the carryover does not operate to reduce what the employee could otherwise elect for the next plan year. For example, if allowed under the terms and conditions of the health FSA, an employee may (1) carryover up to $500 from the 2014 plan year, and (2) make up to $2,500 (as indexed) in salary reduction contributions for the 2015 plan year for a total benefit of $3,000 available in the 2015 plan year.
Mutual Exclusivity with Grace Period. As described above, a basic requirement for the carryover feature is that the health FSA cannot have a grace period operating with respect to the same plan year end. This requirement creates a potential issue for employers who want to implement the carryover feature for the 2013 plan year. If the plan currently includes a grace period, the grace period following the 2013 plan year would need to be eliminated in order to allow a carryover at the end of the 2013 plan year. For plans that are near the end of their plan year (e.g., calendar year health FSAs), eliminating the grace period at this late date raises a number of important issues. Employers in this situation should consult with legal counsel before amending their plans with respect to the 2013 plan year.
Not Applicable to DCAPs. The new IRS guidance does not allow a similar carryover feature under a dependent care FSA. The feature may be used only by a health FSA, including a limited purpose health FSA.
Impact on HSA Eligibility. If an account balance is carried over under a full scope health FSA, the participant will be a participant in the full scope health FSA for the new plan year. Under existing rules, an employee participating in a full scope health FSA is ineligible to make or receive HSA contributions for the entire plan year. Accordingly, if the general rule continues to apply, participants who carry over an account balance under a full scope health FSA could not make or receive HSA contributions during the following plan year, even if they do not make a new election under the full scope health FSA for that new plan year.
Note: The IRS guidance did not address the interaction between a carryover and the general rules regarding HSA eligibility. Possible approaches that would allow participants who are entitled to a carryover to preserve their HSA eligibility include giving them an opportunity to waive the carryover or transferring the carryover to a limited scope health FSA. The IRS has not formally authorized either of these approaches. It is our understanding the IRS has received many calls with respect to what can and cannot be done; items not addressed in the guidance; etc. Hopefully, clarification or additional guidance will be issued so that all entities impacted may benefit from the substance of these conversations. In the meantime, employers who offer an HDHP with HSA contributions should consult with counsel before implementing the carryover feature.
More Issues To Come. As is often the case, guidance answering one question often spurs numerous other questions. As described above, this guidance is typical in that respect. There are also other issues, including application of COBRA, preserving excepted status for purposes of Health Care Reform, and nondiscrimination testing, that will require attention. Unfortunately, the time frame for making the decision to implement the carryover feature is rather short, at least for employers who want to add it for 2013. As a result, the decision likely will be made without the benefit of clear answers to some of these questions.
As noted above, adding the carryover feature is a matter of plan design which requires a plan amendment. In general, an employer must amend the health FSA on or before the last day of the plan year to add the carryover feature. A special transition rule is provided for 2013. A carryover may be allowed from the 2013 plan year to the 2014 plan year provided the plan is amended to reflect the change by no later than the last day of the 2014 plan year.
To Do Items:
- If your health FSA includes a grace period, consider the impact of eliminating the grace period on participants. This consideration is especially important if you are considering adding the carryover for the end of the 2013 plan year.
- If you offer an HDHP with HSA contributions, consider the impact of allowing the carryover on HSA eligibility and consult with counsel regarding options for minimizing that impact.
- If you decide to add the carryover feature, ensure that the necessary plan amendments and participant communications (e.g., Summary of Material Modification) are adopted and distributed in a timely manner.
If you have any questions or would like assistance with any of the foregoing items, please contact us.