Company update:

Captain401 is now Human Interest!

Read More

Get Started.

How to Budget Your Flexible Spending Account (FSA) Carryover

By Damian Davila

Now that the beginning of the year is here, individuals who religiously contributed to their Flexible Spending Account (FSA) plans need to take steps to prevent losing the hard-earned dollars on their plans. Even if you or your spouse forgot about the December 31 deadline to spend your health FSA monies, there may still be a way to spend some or all of those funds in 2017 (or any other year). Let’s review the “use-or-rule” from the IRS, list of permissible carryover options, difference in carryover between a FSA and an Health Savings Account (HSA), and set of guidelines when spending carryover amounts in 2017.

An overview of the “use-it-or-lose-it” rule

FSA plans have a long history that dates back to 1970’s. The IRS created FSA plans to allow employees to use pre-tax dollars for eligible medical expenses and dependent care expenses not covered by their employer-sponsored health plan. Just like contributing with pre-tax dollars to a retirement account, setting aside pre-tax dollars in a FSA allows plan holders to reduce their taxable income. The only catch was that any unused balance on a FSA as of December 31st wouldn’t carry over to the next year. This went on for decades and it wasn’t until 2005 that the Treasury Department and IRS modified the “use-or-lose” rule by adopting a grace period rule. Under the grace period rule, employees may have an extra period of up to two months and 15 days immediately after December 31st to use amounts remaining from the previous year. In November 2013, the IRS further modified the “use-or-lose” rule by providing employers the option to allow up to $500 of unused monies at the end of the year to be paid or reimbursed to plan participants for qualified expenses in the following year, foregoing the grace period rule.

Contact your employer to find out your carryover options

This means that you need to contact your HR department right away to find out what is the applicable carryover rule to your FSA. Since plans vary per company, you should go straight to the source right away. Here is a breakdown of the carryover options that may be offered by your employer.

Option 1: Grace period of two months and 15 days

The best case scenario is that your employer give you until March 15th, 2017 (or any subsequent year) to spend all of your unused funds in our FSA. Since the maximum contribution limit to a health FSA was $2,550 in 2016, your carryover is capped at $2,550. Even though the maximum contribution limit to a health FSA is $2,600 in 2017, carryovers from 2016 to 2017 are still capped at $2,550. In this scenario, any unused funds from 2016 that aren’t used by March 15th would be lost.

Option 2: Carryover is limited at $500

In this scenario, your employer only allows you to carry over only up to $500 in unused funds in your FSA.
  • If you were to have $750 balance in your FSA by the end of 2016, then you would only be able to carry over $500 into 2017 and lose the extra $250.
  • On the other hand, if you were to have a $350 balance in your FSA by the end of 2016, then you would be able to carry over the full $350 into 2017.

Option 3: Carryover is limited to an amount under $500

Keep in mind that the IRS’ November 2013 amendment to the “use-or-lose” rule allows employers to set a carryover amount under $500. So, if your employer limits carryovers to $300 for example, then that’s the maximum amount that you can carry over into the next year. The good news about options 2 and 3 is that there is no deadline to spend the permitted carryover amount and they don’t count towards the current year’s contribution limit. In 2017, this means that a carryover of $400 wouldn’t affect your ability to contribute up to $2,600 to your FSA throughout the year.

Option 4: Employer offers no grace period and no carryover option

In the worst case scenario, your employer believes that it’s not in his best interest to offer either option. While the IRS provides employers the option to provide a grace period of two months and 15 days or set a carryover amount of up to $500, the agency doesn’t require employers to offer either one of those. If this is the case of your FSA, then you’re out of luck and have lost your unused funds from 2016.

The carryover difference between a FSA and a HSA

Remember that there is one more type of FSAs and that there are also HSA plans available to individuals with a qualifying high-deductible health insurance plan (HDHP) to cover out-of-pocket medical expenses. If you’re a HSA plan holder, then you don’t have to worry about grace period or carryover rules. The full unused balance in your HSA is eligible to be carried to the next year without restrictions. To learn more about HSAs and other types of FSAs, review Beyond Health FSA: Dependent Care, Adoption Assistance and More.

Here are some tips when spending your carryover amounts this year

1. Make sure to use your FSA correctly

Your health FSA only covers eligible medical, dental, and vision expenses that are out-of-pocket. In a rush to spend unused amounts from last year subject to the grace period rule (March 15th), don’t make the mistake of paying for the portion of expenses covered by your health plan. This is illegal and could land you the usual IRS penalty of up to 25% for filing an inaccurate tax return if caught during an audit.

2. Think beyond prescriptions and medical appointments

Depending on the availability of your preferred physician and your need for prescription drugs, you may have limited ways to spend your FSA dollars. Review the rules of your plan and you may find out that you may be reimbursed for qualifying diagnostic devices, smoking cessation programs, weight-loss programs, chiropractors services, and many other types of expenses. Read the fine print and find out whether or not you’ll need a letter of medical necessity from your doctor to get reimbursed for a specific item or service..

3. Look for FSA-approved items online or in-person

Some employers may offer you access to an online store with all FSA-approved items in it. Take a look at the available items and compare the prices of eligible items to those at your local pharmacy. This way you could make the most out your FSA dollars. Many drug stores include in the receipt whether or not a purchase is FSA-eligible.

4. Revise your FSA contribution for next year during open enrollment

If this isn’t the first year that you end up with a large, unused balance by December 31st, consider decreasing your FSA contribution during the next open enrollment period. For most FSA plans, the open enrollment period for 2017 is now over. Unless you have a qualifying event, such as marriage or birth of a child, coming up, you will have to wait until later on this year to adjust your paycheck deduction.

5. Keep better track of eligible expenses

To help you determine a more appropriate paycheck deduction for your health FSA, keep track of all eligible out-of-pocket medical expenses throughout the year. You could also look up totals from past years through your federal tax returns or statements from your health insurance provider. Determine a number that is big enough to meet your out-of-pocket expenses but that it doesn’t exceed the carryover limit from your employer, if applicable, by a lot.

6. Consider switching from a FSA to a HSA

Depending on your family’s medical history, you could expect to spend a lot in health care later down the road. When contributing with pre-tax dollars makes sense for you to build a “just in case” medical fund, then you could benefit from a HSA. With a HSA, you can carry over any unused balances and invest those monies in a wide variety of funds, including mutual funds and bonds. And as long as you use HSA monies for eligible medical expenses, you don’t pay any taxes! Some financial advisers suggest using a HSA for saving for medical expenses during retirement because paycheck contributions with pre-tax dollars to your HSA aren’t subject to the Federal Insurance Contributions Act (FICA) tax and reduce your taxable income. On the other hand, pre-tax contributions to a retirement account only reduce your taxable income. Of course, there are also some disadvantages to using a HSA. For example, there is a 20% penalty when making withdrawals for non-medical expenses before age 65 and you can only contribute up to $3,400 ($4,400 if age 55 and over) in 2017 to an HSA for individual coverage. In comparison, you only get a 10% fine for early distributions from a 401(k) before age 59 ½ and you can contribute up to $18,500 ($24,500) in 2017 to a 401(k). Contact your HR department to learn more about the rules and eligibility criteria of your employer’s HSA, if applicable.

The bottom line: Take action today

Don’t wait any longer and set up an appointment with your HR department to find out if your employer offers either a grace period or carryover amount for unused FSA funds from 2016. Once you find out the available carryover option from your employer, you’ll be in a better position to make more informed decisions in the near future and on the next open enrollment period.

Check out our free, online resources to learn more about 401(k)s for you and your company.

GET RESOURCES NOW