IRS eases rules on healthcare flexible spending accounts

Workers faced with forfeiting unused money in their flexible spending accounts for healthcare expenses may be getting some relief under a new federal rule.

The U.S. Treasury Department and Internal Revenue Service changed the use-it-or-lose-it rule for flexible spending arrangements, or FSAs, to allow account holders to carry over as much as $500 from one year to the next without penalty.

Many workers have been reluctant to put money into the plans for fear of losing whatever they don’t use, resulting in long-standing complaints about how the pretax FSAs work.

Typically, they must estimate before the year starts how much they might spend on healthcare, and employers regularly deduct money from their paychecks before taxes. Any amount left over at the end of the year would go back to the employers.

With less risk of such forfeitures now, experts predicted that more workers, particularly lower- and moderate-income employees, would take advantage of the deductions for everyday medical expenses, such as co-pays, over-the-counter drugs and other items not normally covered by health insurance.

“We are always looking for ways to provide added flexibility and common-sense solutions to how people pay for their healthcare,� Treasury Secretary Jacob Lew said Thursday.

Treasury officials began taking public comments on the change last year, and they said the response was overwhelmingly in favor of giving workers more leeway.

The new rules go into effect immediately, but they aren’t mandatory for employers. Firms can decide whether to make the change and when to make it.

In a recent survey of large employers, 86% offered FSAs for healthcare expenses, but only 23% of workers participated, according to Mercer, a benefits consulting firm. In all, federal officials estimated that 14 million American families use the spending accounts.

Federal officials said employers could take advantage of this new rule as soon as this year. But benefits consultants said it will be difficult for most employers to make the switch that fast with open enrollment season already underway at most companies.

“Starting Jan. 1, 2015, I think there will be greater uptake simply because of the timing,� said Laura Baker, a principal at Mercer.

Because the funds are deducted from paychecks on a pretax basis, less of a worker’s earnings are subject to tax.

The average worker contribution was $1,484 last year, according to Mercer’s survey of large employers. The percentage of overall dollars forfeited was 4%.

Treasury officials said they didn’t have figures on how much is lost annually, but they said the new rule could eliminate most forfeitures, which are often below $500 in value.

One benefits administrator, Alegeus Technologies in Waltham, Mass., estimated that 1 in 4 flex-spending participants suffers a forfeiture each year.

“The Treasury Department has eliminated the most significant barrier to FSA participation, namely consumers’ fear of losing their money,� said Bob Natt, executive chairman of Alegeus. “This will certainly lead to growth in FSA adoption.�

Employers are not allowed to return the money to individual employees. Health experts said most use it to offset the cost of administering employee benefit programs.

The rule change also could reduce the incentive by workers for unnecessary spending at year-end to avoid losing the money set aside.

Some employers offer a grace period to workers, allowing them to use prior-year balances until March 15 of the following year. Treasury officials said employers would have to pick between a grace period or the rollover option because they won’t be allowed to do both.

Sen. Orrin Hatch (R-Utah) praised the new flexibility from the Obama administration.

“Allowing Americans who have one of these accounts to roll $500 over to the following year just makes sense,� Hatch said.

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