Deciding how much to contribute to your Flexible Spending Account (FSA) at the beginning of your plan year can feel like it’s half fortune telling and half science. The good news is that two policies: the FSA Rollover and the FSA Grace Period can help alleviate the stress of choosing the exact correct amount to contribute to your FSA each year.
FSAs are savings accounts into which you can deposit pre-tax money in order to pay for qualified medical expenses. They must be employer-sponsored (meaning they aren't available in the private market), but unlike HSAs, they aren’t tied to a specific type of health insurance plan.
You must choose the annual amount you want to contribute during your open enrollment period and your employer will then deduct the appropriate amount from each paycheck. If you want to change your elected contribution levels outside of open enrollment, you can typically do so only if you’ve experienced a qualifying life event like getting married or having a child.
Note: The IRS has adjusted some of the rules governing when employees can make changes to FSAs as well as rollovers and grace periods for 2020 due to the COVID-19 pandemic. For information regarding 2020 rule adjustments, see the FSA Rollovers and Grace Periods: COVID Relief section below.
There are three types of FSAs:
- Healthcare FSAs
- Dependent Care FSAs
- Limited Purpose FSAs.
Contributions to Healthcare FSAs are intended to help participants pay for out-of-pocket medical expenses (i.e. qualified medical expenses) that include, but are not limited to: deductibles, copays, prescriptions, over-the-counter drugs for which you have a prescription (insulin refills don't need a prescription), out-of-pocket dental and vision care, crutches, blood sugar test kits and bandages. You can’t use your contributions to pay for health insurance premiums, over-the-counter drugs without a prescription, long-term care or any expense covered under your health insurance plan.
Dependent Care FSA
Dependent Care FSAs were created to help working parents and caregivers pay for child or adult daycare of dependents who live with them the majority of the time. The care for which contributions pay must be essential to allowing the parent(s) and caregivers to work or look for work (so no date nights). The list of allowable expenses includes: nannies, babysitters, daycare, preschool, summer day camp, and before and after school care for children under the age of 13; and adult daycare for a spouse, parent, or other relative who is physically or mentally disabled.
Limited Purpose FSAs
Limited Purpose FSAs can only be used to pay for out-of-pocket dental and vision expenses.
FSA Contribution Limits, Expirations and Rollovers
The 2020 contribution limits for the three types of FSAs are as follows:
- Healthcare FSA: $2,750. You can use this money to pay for medical expenses for you, your spouse and any dependents which you claim on your tax return. If both you and your spouse have an FSA, you can each contribute up to $2,750 in your respective accounts.
- Dependent Care FSA: $5,000 for a married couple filing jointly, or $2,500 for each individual FSA if you each have a separate account.
- Limited Purpose FSA: $2,750, and you can use this money to pay for you, your spouse and your dependents.
Until 2012, there were no such things as FSA rollovers or grace periods. If you didn’t spend your total contributed amount by the end of your plan year, you forfeited any remaining funds back t your employer. But this led to wasteful spending at the end of each plan year as participants raced to find something on which they could use their leftover savings. But then the IRS and Treasury Department made a rule change that truly benefited people contributing to these types of accounts.
Now, employers have the option to EITHER allow employees to rollover up to $500 of FSA savings to the following plan year OR they can give employees a 2 ½ month grace period following the end of the plan year during which employees can use any remaining funds. Here are a couple of examples of how this works:
Example 1: The FSA Rollover
Let’s say Drew has contributed the maximum annual amount to his FSA account ($2,750) but he’s only used $2,000 of it by the end of his plan year. Let’s also say, Drew’s employer allows him to rollover up to $500 of unused funds to the following year and Drew elects to take advantage of this. That means that Drew will start the following plan year with a $500 balance in his FSA (plus any money his employer contributes at the beginning of the year) but he will forfeit the remaining $250. He can then choose to contribute up to the maximum allowed for that year or he can adjust his contributions to account for that rolled over amount.
Example 2: The Grace Period
Natasha has planned to contribute the maximum amount to her FSA ($2,750) and her plan year ends December 31st. By November 15th, she’s only used $1,150 of her contributions. Without a grace period, Natasha might be scrambling to try to find ways to spend the remaining $1,600. But since her employer does give employees a 2 ½ month grace period, she has until March 15th to use her remaining FSA balance. Because of this, she’s able to schedule an elective procedure for January for which she uses her previous year balance to pay for the related out-of-pocket expenses.
FSA Rollovers and Grace Periods: COVID Relief
Due to the COVID-19 pandemic, the IRS and Treasury Department have instituted new guidelines and allowances that apply to FSAs for just 2020. So if you’ve found your FSA over or under-funded due to the current environment, see if any of these changes might help your situation.
- Employees can change their contribution levels outside of open enrollment. This only applies to contributions you make going forward. Past contributions you’ve made must remain in your account.
- Employees can open a new FSA or restart contributing to an existing FSA outside of open enrollment.
- Employers can extend their 2019 FSA grace period to December 31, 2020 (if their plan year follows the traditional calendar year), and June 30, 2021 if they have a split-year schedule. Employees can rollover up to $550 of their 2020 FSA funds to 2021. Employers can allow employees to change their insurance coverage.
It’s up to your employer whether or not it wants to offer these new leniencies, so if you have any questions, contact HR or your FSA administrator.
How Do I Know if My FSA Allows Rollovers?
It’s up to your individual employer whether or not they want to allow you to rollover any of your contributions. So to find out if your plan allows for this, contact your HR Department or FSA administrator. If you have any other questions regarding FSAs, checkout Lively’s FSA page.
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.