McKay Hochman - Commentary

Commentary

Use It or Lose It
October 13, 2005
The IRS has added a grace period to the “use-it-or-lose-it” rule for flexible spending accounts (FSAs). The grace period is 2½ months after the end of the plan year. Our plan document has been updated to include this provision. Optional Grace Period Amendment Under the "use-it-or-lose-it rule" cafeteria plans are required to forfeit unused participant contributions remaining at the end of a plan year. This rule may have an especially harsh impact on participants in either a health FSA or dependent care FSA who have overestimated anticipated expenses, and may possibly affect the legal ability to use premium conversion contributions made at the end of a plan year to pay for coverage that extends into the following plan year. To soften the negative effects of this rule, the IRS recently issued guidance (Notice 2005-42) that permits a cafeteria plan to be amended to establish a "grace period" that does not exceed two months and 15 days after the end of the plan year. Grace Period Amendment (including WFTRA changes) and SMM added to McKay Hochman’s Cafeteria Plan Document Output If the optional grace period amendment is adopted, participants may apply their unused contributions attributable to the previous plan year to pay or reimburse services provided to them or their beneficiaries during the grace period. This amendment may be adopted retroactively for 2005. However, there is no legal requirement for an employer to adopt the grace period amendment, and a plan may elect to continue to operate under the current "use-it-or-lose it" rules. If that is the employer's desire, then he or she should leave this section of the amendment blank. For those employers wishing to use the new rules, we have added a model amendment to our Cafeteria Plan Document that allows employers to reimburse medical and/or dependent care services incurred within one month, two months, or two months and 15 days after the end of the plan year with prior year contributions. The model amendment also updates the Cafeteria Plan Document for other recent law changes effective in 2005, including the changes to the Internal Revenue Code definition of who is a "dependent". Generally, your clients should adopt the amendment before the end of the 2005 plan year. A plan adopting the grace period would administer claims in the following manner:
	A plan participant made an election of $2,000 of coverage under the Health Care Expense Reimbursement Plan for the 2005 Plan Year. At the end of the Plan Year, $300 remained in his Health Care Flexible Spending Account. The participant then elects $2,000 of coverage for the 2006 Plan Year. During the second week of the 2006 Plan Year, the participant incurs $700 in eligible health care expenses and submits a claim for reimbursement. His or her claim will then be reimbursed as follows: $300 of the claim will be paid from the unused portion of his or her account related to the 2005 Plan Year and $400 will be paid from the amount available for paying claims related to the 2006 Plan Year.
WFTRA changes to Basic Plan Document The Working Families Tax Relief Act of 2004 (or WFTRA) changed how the term "dependent" is defined under the Internal Revenue Code. WFTRA became effective in 2005 and impacted how benefit plans may process claims. As a result, regardless of the grace period decision above, plan documents must be amended to conform to this new law and we have included conforming language in our model amendment.



Back to Commentary Index

WFTRA changes to Basic Plan Document