FSA Grace period provides more time, questions
A new ruling may allow more time for participants to spend
funds set aside in a Flexible Spending Account (FSA). The Treasury issued Notice 2005-42 on May 18, 2005 allowing plan
sponsors to design plans with up to an additional 2 1/2 month grace period
following the end of the plan year to incur expenses before the
use-it-or-lose-it rule would apply.
Sounds like a great thing for everyone and easy too, right? Well, possibly,
but there are things to consider before jumping on the wagon and allowing the
additional time.
FSAs have been a beneficial way for employees to save
pre-tax dollars in an account to pay for medical expenses. However, regulations have always prohibited
participants to carry-over any unused funds at the end of the plan year,
commonly referred to as the use-it-or-lose-it rule. This was one of the biggest
challenges to FSA success for employers.
Many participants were skittish about their ability to predict
FSA-approved expenses therefore many opted not to participate.
The ruling reduces the risk of the use-it-or-lose-it rule by
allowing up to an additional 2 1/2 months, after the end of a plan year, for a
participant to incur expenses that can apply against the prior year's level of
available benefits or contributions. In other words, amounts from one year may
be used for expenses/benefits incurred in a subsequent year but only during the
grace period. Any amounts not used for expenses incurred during the grace
period are forfeited.
Not only does this rule apply to FSAs, but it also pertains
to amounts set aside for coverage, commonly referred to as Premium Only Plans.
The new rule resolves the issue of employee pre-tax contribution withheld in
the last month of the plan year that is then put towards the cost of coverage
provided in the first month of the subsequent plan year. The ruling answers
this common practice by providing official guidance, however there are still
other unanswered questions on how this will work with existing law and how many
administrative and compliance headaches will occur as a result of the changes.
The new rule is optional and employers/plan sponsors have
several options to choose from when determining how to adopt the change. The following is a list of options available
for plan designs and applicable implementation steps:
·
Amending plan documents. Employers/plan sponsors
are not required to implement the rule. However, if the rule is implemented the
plan document must be amended prior to the end of the plan year in which the
rule will apply.
·
Grace period must apply to all participants if
adopted. The intent is to prevent
employers from only offering the additional time to certain plan
participants. However, the ruling could
be interpreted as preventing employers from applying the grace period to
certain benefits such as only the Health FSA and not for dependent care. However, the indication is that this was not
the intent and it could be applied to just one of these plans.
·
Grace period allowed. The grace period cannot be longer than the 15th day of
the third month following the end of the plan year. The ruling does allow for the grace period to be shorter.
·
Carry over amounts.
Any carry over amounts may not be used for any other taxable or
non-taxable benefits. Unused funds may only be used to reimburse eligible
Health FSA expenses incurred during the grace period and likewise for unused
dependent care amounts. Carry over amounts may not be transferred to an HSA or
an HRA.
·
Run out period. Each employer/plan sponsor may
implement a run out period following the grace period, but it is not
required. During this run out period
participants could submit expenses incurred during the grace period that are
turned in within the run out period.
In addition to determining how to apply the rule,
the new grace period raises legal and practical issues. Many of the issues will need to be resolved
with official guidance from the Treasury Department. Following are some of
the issues and unresolved questions:
·
Informal comments made by IRS stated the grace
period would not cause a Health FSA to lose its status as an excepted benefit
under HIPAA's portability rules. Most Health FSAs currently qualify as an excepted benefit under
HIPAA's portability rules. Originally, the concern was the grace period rule
might change the status of the Health FSA to be creditable coverage resulting
in additional requirements.
·
The grace period rule may cause the Health FSA to be
subject to the full COBRA continuation coverage period. Under COBRA, Health
FSAs may be offered but not required to continue after the end of the plan year
in which the qualifying event occurs if certain conditions are satisfied. It is also not clear whether the carry over
amount would be considered for purposes of determining the applicable COBRA
premium. It could change that all
Health FSAs implementing the grace period would be subject to the full 18, 29
or 36 months of COBRA. In addition, clarification is necessary regarding the
grace period and whether it is required to be extended to Qualified
Beneficiaries as it is for active employees.
·
The grace period may require dependent care benefits
to be adjusted for use or carryover due to statutory maximum for the year. In
addition, reporting headaches may arise. Under a Dependent Care Assistance Program (DCAP), benefit limits are
$5,000 (if single or married filing jointly) or $2,500 (if married filing
separate) during a calendar year. The
maximum reimbursement is based on the actual benefits received during a
calendar year and not necessarily the amount that is salary reduced. Therefore,
if the new grace period rule is implemented for dependent care benefits an
individual must look at the carryover amount when making an election for the
next calendar year. It is also unclear how the grace period will affect DCAP
W-2 benefit reporting obligations.
·
Restrictions to carry over amounts. Nothing in
the rule prevents an employer/plan sponsor from putting a limit to the
carryover amount.
·
Administrative systems need reviewed to ensure the
grace period rule could be properly administered. The grace period rule may be difficult to
administer. Systems must be revised to
properly track account balances from the prior plan year and segregate them
from the current year so that prior year funds are not used to reimburse
expenses incurred after the end of the grace period. Procedures need to be put in place to charge claims against any
carry over first and make sure that the claims are not resubmitted under the
current year.
·
Discrimination testing issues. Nothing in the guidance provides information
on how the grace period would affect discrimination testing requirements.
·
Irrevocable election issues. There are questions to how the grace period
will affect participant elections.
For more information on what is
available, along with ability to see what employers and employees can save with
these accounts, call 800-779-6384 or visit our website at www.benefitsolved.com to
view information available to assist with an FSA Plan
Article contributions from
Ashley Gillihan and John Hickman, legal counsel with Alston & Bird, LLP,
one of the leading legal firms in the U.S., specializing in employee benefits.
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