January 11, 2021
On December 27, 2020, a major government-funding bill focused on COVID-19 economic stimulus issues became law as part of the Consolidated Appropriations Act 2021 (the 2021 Act). One notable benefits-related provision in the 2021 Act relates to health flexible spending accounts (HFSAs) and dependent care FSAs (DCFSAs). The 2021 Act FSA temporary rules expand on prior IRS FSA relief granted in 2020. The 2021 Act lets employers allow employees to make prospective FSA changes during the 2021 plan year without a corresponding status change, and/or to carry over unused FSA funds or extend existing grace periods for up to 12 months for plan years ending in 2020 and/or 2021.
Background on FSA Carryover and Grace Period Exceptions – THE BASIC RULES
Generally, an FSA must incorporate a “use-it-or-lose-it” rule under which unused benefits or contributions to the FSA remaining as of the end of a plan year are forfeited. FSAs typically offer a “run out” period immediately following the end of the plan year during which participants may submit documentation to request reimbursement of eligible expenses incurred during the previous plan year. The basic rules provide for two exceptions to this “use-it-or-lose-it” rule that cafeteria/FSA plans are permitted (but not required) to adopt, and an FSA may adopt only one of these two exceptions. Note that a HFSA can allow one or the other of these exceptions (a carryover feature OR a grace period), but not both.
- A carryover rule may be adopted (by HFSAs only) which permits unused amounts remaining in an account at the end of a plan year (up to a specific dollar limit) to be used in the following year. The IRS extended temporary relief in 2020 that allowed HFSA sponsors to choose to increase the maximum unused amount that may be carried over under HFSAs from $500 to $550 for carryovers from 2020 into 2021.
- A grace period rule may be adopted (by HFSAs and DCFSAs) which permits unused amounts to be available to pay for qualifying expenses incurred during the period of up to 2-1/2 months following the end of that plan year.
The IRS extended temporary relief in 2020 for these two basic exceptions that allowed FSA sponsors to choose to permit employees to apply amounts that are unused and that remain in a HFSA or a DCFSA as of the end of a grace period or plan year ending in 2020, to pay or reimburse medical care expenses or dependent care expenses, respectively, incurred through December 31, 2020. Note that a calendar plan year HFSA with a carryover provision could not benefit from this extended period because its plan year ends December 31, 2020.
New Increased FSA Flexibility and Election Change Options – THE NEW TEMPORARY RULES
The 2021 Act temporary relaxes the above existing FSA rules and provides plan sponsors with new options for increasing participant flexibility with respect to FSAs as follows:
- Provides employers the option to amend their plans to allow employees to:
- Carryover unused amounts from plan year ending in 2020 to the 2021 plan year
- Carryover unused amounts from plan year ending in 2021 to the 2022 plan year
- Provide up to a 12-month grace period at the end of the 2020 plan year
- Provide up to a 12-month grace period at the end of the 2021 plan year
- Provides employers the option to allow employees who cease participation in a HFSA during calendar 2020 or 2021 the opportunity to receive post-termination reimbursements from unused benefits or contributions through the end of the plan year in which such participation ceased (including grace period if applicable).
- Provides employers the option to amend their HFSA and/or DCFSA to allow employees to make prospective election changes for plan years ending in 2021 (with no change in status).
- Provides employers the option to amend their DCFSA to allow for a special carry forward for certain expenses after a child turns 13.
This FSA flexibility relief is temporary and it is optional. Employees may welcome and expect their employer to offer the flexibility, but employers must consider the administrative challenges related to the relief and coordinate with their vendors, and then determine how or if they should implement some, all, or none of this FSA relief. Employers also need to decide if they will put parameters around FSA changes as well (e.g., giving a one-time window to make a prospective change). Any changes will have to be communicated to all eligible employees and cannot be offered only to employees who ask for relief. And once an employer decides to allow any of the FSA relief in 2021, they will need to approve a plan amendment by the end of 2022.
Detailed Summary of the New Increased FSA Flexibility and Election Change Options
Carryover Rule or Extended Grace Period – Under the 2021 Act, an employer may permit extended grace periods (up to 12 months) or expanded carryovers for HFSAs and DCFSAs for plan years ending in 2020 and/or 2021. For example, an FSA participant with unused FSA funds on December 31, 2020 could be permitted to have until December 31, 2021 to incur expenses that may be paid for with the unused 2020 HFSA funds either as a result of an extended 12 month grace period or temporarily expanded carryover rule.
- Carryovers -The $550 carryover permitted in HFSA plans is modified for plan years ending in 2020 or 2021 such that a plan can provide that all unused amounts be carried into the next plan year. The Act also permits a DCFSA plan to add a carryover for the 2020 and 2021 plan years (previously, DCFSAs could not have a carryover feature).
- Grace Periods – In HFSAs and DCFSAs that have a grace period, the grace period (normally 2.5 months following the end of the plan year) in which unused 2020 and 2021 plan year funds can be used in the next plan year can be extended for up to 12 months. For example, a March 15, 2021 grace period could be extended to December 31, 2021, giving a participant the entire following year to use up 2020 funds.
- An employer may choose either the carryover or the grace period for each FSA, but not both for the same FSA for 2020 and 2021. So an employer may not offer a 2020 carryover and grace period that applies to the same FSA. But, for 2020, an employer can, for example, offer a carryover for both the HFSA and the DCFSA, or a carryover for the HFSA and a grace period for the DCFSA.
- Adopting the temporary rules will likely increase costs for plan sponsors. For example, plan sponsors adopting the Act’s relaxed carryover or expanded grace period should expect additional FSA communication and administration issues/costs and also fewer HFSA experience gains to offset experience losses. An important characteristic of HFSAs is that the full annual contribution amount must be available to participants on the first day of the plan year. If a participant terminates employment having spent more HFSA funds than the participant contributed, the HFSA incurs an experience loss. Employers typically benefit from the use of unused HFSA account balances to offset the losses from those that spend more than they contributed and terminate mid-year, so permitting this new flexibility under a HFSA would likely reduce the amount of experience gains from forfeitures an employer has to offset its experience loses.
- Annual HFSA limits: A carryover or grace period will not reduce or count against, or otherwise affect, the HFSA salary reduction limit ($2,750 for 2021) otherwise applicable to the plan year following the plan year in which the carryover or grace period was utilized.
- Annual DCFSA limits: It appears this FSA relief may not change the maximum amount that can be excluded from an employee’s income (generally $5,000 per year, but $2,500 for married employees filing separately) as reimbursement of expenses for qualified dependent care assistance services provided during a tax year. So a participant could have taxable income if their DCFSA reimbursements exceed the DCFSA exclusion for a calendar year as a result of a grace period. We are hoping the IRS will issue clarifying guidance.
- HSA eligibility should be considered by employers that offer a qualified high deductible health plan (HDHP) as the HFSA relief (including expanded carryover, grace period extension and post-termination reimbursements) may adversely impact eligibility to contribute to a health savings account (HSA). Electing the temporarily expanded carryover relief may be preferable for plans that contain an HSA option. The IRS has previously clarified that carryovers that are credited to a limited purpose or post-deductible HFSA account will not disqualify an individual’s coverage for HSA eligibility purpose (such relief does not apply to HFSAs that utilize a grace period).
Post-Termination HFSA Reimbursement – Plan sponsors may amend their HFSA plans to permit a HFSA participant to continue to submit claims up to the amount of the unused balance for reimbursement of expenses that were incurred after the employee’s termination of employment, but prior to the end of that plan year (or prior to the end of the grace period if the plan has a grace period). This is similar to an existing rule for DCFSAs.
- This new rule does not permit a payout, rather it permits participants to access funds remaining in their HFSAs on the date participation ceases without electing COBRA. Participants who have not overspent their account would still have to elect COBRA if they wished to contribute to their HFSAs for the remainder of the plan year following termination of their participation.
- It is unclear whether allowing a HFSA spend down would apply just to unused contributions as of the termination date or the entire elected amount (as would be required if the uniform coverage rule applied). Additional IRS guidance would be helpful on this issue.
Special Carry Forward for DCFSAs – Normally, dependent care expenses for a child under a DCFSA are only reimbursable until the child attains age 13 (except in cases of incapacity). The 2021 Act considered the fact that some dependents attained the limiting age for DCFSA reimbursement during 2020 (at the height of the pandemic). In this case, a plan sponsor can allow DCFSA participants to continue to receive reimbursements for that child’s dependent care expenses for the remainder of the plan year after the child turns 13 (provided the enrollment period for the plan year ended on or before January 31, 2020) and, if there were unused amounts in that plan year, continue to use any balance remaining during the following plan year until the child’s 14th birthday.
- This special rule can only be applied to plan participants who were enrolled in the DCFSA for the last year whose regular enrollment period ended on or before January 31, 2020 (for most calendar year programs, the 2020 plan year), and who have a child who attains age 13 in that plan year (and if there were unused elected amounts in that plan year, in the next plan year). So if an employee elected in annual enrollment during November 2019 to contribute $5,000 to a DCFSA and her child turned 13 in October 2020, dependent care expenses for that child will not end when the child turned 13, but will continue to be eligible for submission and reimbursement until that child attains the age of 14 in October 2021.
- This special rule has limited applicability in that it provides relief for employees with children who turned 13 in 2020 but for whom no childcare services were available due to the pandemic, so that they can recover in the next following plan year for dependent care expenses incurred.
- This provision does not allow an employee to make a new election. It only allows for spend-down of an existing balance so employees may use any remaining 2020 dependent care FSA funds in 2021 to pay for care provided to children until they turn 14.
Prospective Election Changes – An employer may amend its FSA plans to permit an employee to make a prospective election change, mid-year for plan years ending in 2021, without a change in status. This may include allowing a new HFSA or DCFSA election.
- This only applies to FSA elections and not salary reduction elections for other cafeteria plan benefits (e.g., health insurance).
- This provision will be particularly helpful if the employer decides to permit the availability of roll over of unused funds from the 2020 plan year that were not anticipated to be available for use in 2021 when participants made their elections during the fall 2020 open enrollment period.
- Employers can set the conditions for any such changes. So, for example, employers can limit the number of election changes employees make and can also choose to limit a mid-year HFSA election revocation or decrease to amounts no less than amounts already reimbursed to the employee by the HFSA in the plan year.
These changes are optional for employers. If an employer adopts one or more of the temporary allowed provisions, amendments must be made by the end of the calendar year beginning after the end of the plan year in which the amendment is effective. For example, if an employer adopts a provision effective in 2021, the plan must be amended by December 31, 2022. In addition, the plan must be operated in accordance with the amendment terms as of the effective date of the amendment.
Employers considering adopting any of these changes should contact their FSA plan third party administrator (TPA) to confirm their readiness to implement the changes and if they have any limitations on being able to administer them. Some of the provisions may require changes to internal systems and election forms and summaries and impact debit card functionality. TPAs may impose additional fees to administer the flexibility.
- Employers must decide which, if any, of the FSA flexibility options to adopt.
- Allow FSA election changes for plan years ending in 2021, regardless of whether employee has permitted election change event? Any limits or conditions?
- Allow carryover of unused funds from plan year ending in 2020 to plan year ending in 2021? (Unlimited?) (Decide later in 2021 for plan year ending in 2021 to plan year ending in 2022?)
- Allow grace period for plan year ending in 2020 (up to 12 months)? (Decide later in 2021 for plan year ending in 2021 to plan year ending in 2022?)
- For HFSA, permit a post-termination spend down during 2020 and/or 2021?
- For DCFSA, allow for a special carry forward for certain expenses after a child turns 13?
- Employers should distribute clear communication about any plan flexibility adopted so that plan participants understand exactly what, if any, additional flexibility is included in their plan.
- Employers can expect some participant confusion on these issues as some employers will adopt these enhanced flexibility provisions and others will not. Employees may welcome and expect their employer to offer the flexibility.
- Employers should consider the administrative challenges related to the relief and coordinate with their TPAs to confirm their readiness and if any additional fees will apply. There may be potential delays while administration platforms are updated to accommodate changes.
- Employer amendments must be made by the end of the calendar year beginning after the end of the plan year in which any amendment is effective.
Conner Strong & Buckelew is prepared to assist plan sponsors in determining how plans may be configured to enable the above described FSA changes should employers choose to implement them. Please contact your Conner Strong & Buckelew account representative toll-free at 1-877-861-3220 with any questions. For a complete list of Legislative Updates issued by Conner Strong & Buckelew, visit our online Resource Center.