What options does an employer have with unused FSA funds?

Internal  Revenue Service (IRS) rules provide an employer two options for unused health care flexible spending account (FSA) funds. Previously, employers had to follow the "use it or lose it" rule, meaning that any account balances left at the end of the year were forfeited. An employer must still follow the "use it or lose it" rule for dependent care FSA funds. A dependent care FSA plan allows for a reasonable time for employees to submit claims after the plan year-end, but all dependent care expenses must be incurred by plan year-end.

For health care FSAs, the first option allows employers to add a two-and-one-half-month grace period immediately following the end of each FSA plan year. The other option is to allow participants to roll over up to $610 of unused funds at the end of the plan year (in 2023) and still contribute up to the maximum in the next plan year. Choosing this option, however, has implications for an employer with a high-deductible health plan (HDHP) with a health savings account (HSA) because carryover FSA funds limit HSA contributions.

Under these rules, an employer may choose to adopt the carryover provision or the two-and-one-half-month grace period. It may not offer both. The FSA plan document must be adopted by the last day of the plan year from which amounts may be carried over, provided that the plan informs participants of the carryover provision.

For example, for an employer whose FSA plan allows a two-and-one-half-month grace period, an employee who elects to contribute $1,500 but incurs only $500 of eligible medical expenses during the plan year is allowed the two-and-one-half-month grace period to use the remaining funds. For an employer whose FSA plan allows the rollover of up to $610, the employee is allowed to carry over $610 into the next plan year. The amount in excess of the $610 allowable carryover, which in this example is $390, would be forfeited.

Employers may continue to use forfeited funds to apply to administrative costs incurred during the plan year, or they may credit those leftovers to employees' FSAs in the next year's plan, as long as the employer in no way bases the credit on employees' claims experience and does not violate the Internal Revenue Code Section 125.