3516 / What is a health flexible spending arrangement?

Editor’s Note: Health FSAs typically operate under a “use it or lose it rule.” As participants know, FSA amounts not used by the end of a grace period following the year-end are typically forfeited. Plans are also permitted to allow a $660 (in 2025, $640 in 2024 and $610 in 2023) per-year carryover. Late in 2020, Congress enacted the CAA, which allowed amendments to health FSAs and dependent care FSAs to permit participants to carry over any unused amounts from the 2020 plan year into the 2021 plan year. FSAs with plan years ending in 2021 were similarly permitted to allow participants to carry over all unused amounts into plan years ending in 2022. If the plan already had a grace period in place, the grace period could be extended to 12 months after the end of the plan year. Relatedly, FSAs were permitted to allow employees who stopped participating in the FSA during 2020 or 2021 to continue receiving amounts from the FSA through the end of the year in which the employee stopped participating (including any grace periods and extended grace periods).

Although health coverage under an FSA need not be provided under commercial insurance, it must demonstrate the risk shifting and risk distribution characteristics of insurance. Reimbursements under a health FSA must be paid specifically to reimburse medical expenses that have been incurred previously. A health FSA cannot operate so as to provide coverage only for periods during which the participants expect to incur medical expenses, if such period is shorter than a plan year. In addition, the maximum amount of reimbursement must be available at all times throughout the period of coverage (properly reduced for prior reimbursements for the same period of coverage), without regard to the extent to which the participant has paid the required premiums for the coverage period, and without a premium payment schedule based on the rate or amount of covered claims incurred in the coverage period.¹ Before 2013, there was no statutory limit on contributions to a health FSA, but most employers imposed a limit to protect themselves against large claims that had not yet been funded by salary reductions.

The period of coverage must be 12 months, or in the case of a short first plan year, the entire first year (or the short plan year where the plan year is changed). Election changes may not be permitted to increase or decrease coverage during a coverage year, but prospective changes may be allowed if they are consistent with certain changes in family status. See Q 3506. The plan may permit the period of coverage to be terminated if the employee fails to pay premiums, provided that the terms of the plan prohibit the employee from making a new election during the remaining period of coverage. The plan may permit revocation of existing elections by an employee who terminated service.²

A plan may provide a grace period of no more than 2½ months following the end of the plan year for participants to incur and submit expenses for reimbursement. The grace period must apply to all participants in the plan. Plans may adopt a grace period for the current plan year by amending the plan document before the end of the current plan year.³ Further, beginning in 2014, health FSAs may be amended so that $500 of each participant’s unused amounts remaining at the end of the plan year may be carried forward to the next plan year. However, plans that incorporate the carryover provision may not also offer the 2½ month grace period.⁴