FSA Rollovers vs. Grace Periods
- Ben Luthi
- 6 min read
A Flexible Spending Account (FSA) offers employees the chance to save for medical expenses pre-tax. The arrangement can save you hundreds or even thousands of dollars per year. Be warned, you must use your FSA funds by the end of each plan year.
That is, unless your plan has an FSA rollover or grace period. The Internal Revenue Service (IRS) allows employers to opt-in to one of these options. Both options can help their workers who have an end-of-year balance.
It's important to understand what happens to your funds at the end of the plan year. You don't want to leave money on the table!
The different types of Flexible Spending Accounts
There are three different types of FSA plans you can get. These plans are only available through employers that offer them. In each case, your contributions occur on a tax-free basis. This means you’ll save tax money when you file your return.
Here's a look at each different type of FSA:
- Healthcare FSA: You can use funds for eligible medical expenses, including dental and vision. Eligible people include you, your spouse and any dependents you claim on your tax return. A healthcare FSA can offer a rollover or a grace period.
- Dependent Care FSA: Participants can use money from this account to pay for dependent care of a child or adult. It's intended for individuals who need dependent care so they can work. Dependent Care FSAs don’t offer a rollover option, but may offer a grace period or run-out period.
- Limited-Purpose FSA: This FSA only includes qualifying dental and vision expenses. Limited-purpose FSAs can come with a rollover or a grace period.
The FSA contribution limit for healthcare, limited-purpose, and dependent care FSAs is set by the IRS each year.
Healthcare and limited purpose FSAs are not like HSAs - you do not have to have a qualified high-deductible health plan to use them.
As such, they’re perfect if your health insurance plan doesn’t qualify for an HSA.
How do rollovers and grace periods work?
The default setting for FSAs is the Use It or Lose It rule. This means you give up any FSA funds you don’t spend by the end of the plan year. This is in stark contrast to HSAs. With an HSA you don't have to use your contributions within a certain timeframe.
Beginning in the 2014 plan year, the IRS added a couple of options for employers. These options help limit that loss for workers with funds left over in a healthcare FSA or limited-purpose FSA.
Employers that offer these FSAs can choose to offer a rollover, grace period or nothing at all. The only catch is that they can’t offer more than one option. If your employer doesn’t offer either option, it may choose to offer a run-out period instead.
With an FSA rollover, participants can carry over up to $500 of their unused funds to the following plan year.
Let's take this real life example:
You have a $600 balance at the end of the year. Next year, can start the year off with $500 plus that year's contribution limit. While you did have more money in your FSA left over, you're only allowed to take $570 in 2022 and $610 in 2023 over into the next year.
If you have less than the carryover amount remaining in your account, you can roll over the full FSA balance. What’s more, you can still contribute the maximum amount in the following year.
With the grace period option, employees can get an extra 2.5 months (March 15) to use the previous year’s FSA funds. As long as the service occurs within that grace period, it qualifies.
There’s no limit on how much you can use during an FSA grace period. This means it can be more beneficial if you have more than $500 in remaining funds.
A run-out period is a period of time during your new plan year in which you can still file claims for expenses made in the previous year.
Let's say your run-out period lasts until March 31. You will have until then to file a claim for FSA funds for any eligible expense made by December 31 of the previous year. This can be helpful because there’s often a delay between your service or procedure and when you get your bill.
Which is better?
As an employee, you don't get to choose which FSA extension option you get. Your employer gets to choose — and remember, they may choose not to offer either.
Depending on the situation, you may have some influence in the decision-making process for future FSA plan years. So it’s a good idea to understand both options and their benefits and drawbacks. Discuss options with your employer so future employees can receive these benefits.
Rollover pros and cons
The biggest benefit to an FSA rollover is that you’ll have the entire upcoming plan year to use the funds from the previous year. This setup is helpful if you don’t have any medical services or procedures scheduled at the beginning of the following year.
The downside is that you can only roll over up to the maximum carryover amount. Of you have more than that in unused funds, you’ll still be leaving some money on the table, even if not the full amount.
Grace period pros and cons
The grace period option doesn’t limit how much of the previous plan year’s unused funds you can use. As long as you incur the expense within the first 2.5 months of the following plan year, you can get reimbursed.
That said, the amount of time you have to use your FSA funds is much shorter than with the rollover alternative. If you aren’t proactive about using it all at the beginning of the year, you may still lose some of it.
Other tips for using your FSA money
Make it a goal to use your entire FSA balance by the deadline. Here are a few options to consider:
- Know what qualifies: The IRS provides a list of eligible medical expenses and qualified dependent care expenses. Read through the list to find out if you’ve incurred expenses that you didn’t know were eligible. Remember that if you have a limited-purpose FSA, your options are limited in comparison to a healthcare FSA.
- Visit the FSA Store: The FSA Store only offers qualified products for your healthcare FSA. You can shop by category and search for products you could use to improve or maintain your health. You can also shop for FSA-eligible items on Amazon.com.
One thing to avoid is prepaying for medical care that will not happen during the plan year or grace period. An expense isn’t considered incurred unless the actual service occurs during the account’s plan year. If you try to use your FSA funds to pay for care in advance, it may not be eligible for reimbursement.
The bottom line
The FSA rollover and grace period offer relief to account holders at the end of the year. If you have an FSA, your employer gets to choose which one to offer, and it may not give you either option.
Speak with your HR representative to find out what your employer offers. Regardless of which option they chose, it’s important to be mindful of your account balance. It’s also important to have a plan to use all the money before the deadline. You’ll be able to maximize the value your FSA offers without the stress of trying to catch up the following year.
If you do have unused FSA money at the end of the year, consider adjusting your contributions. This way, you may be able to avoid having a surplus of funds in the upcoming year.
Disclaimer: the content presented in this article are for informational purposes only, and is not, and must not be considered tax, investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, including fund prospectuses, and consult with appropriate tax, investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.