Despite the name, “flexible spending accounts” (FSAs) haven’t offered enough flexibility to suit some employees. But now the tide may be turning.
With an FSA, you can elect to allocate part of your salary to a special account for health care or dependent care expenses. Your contributions to the spending plan are made on a pre-tax basis and there’s no tax on withdrawals to pay for eligible expenses.
Sounds like a good deal, right? However, a “use-it-or-lose it” rule for FSAs often has discouraged participation. Under this rule, you must forfeit any funds remaining in the account at the end of the year.
But the IRS relaxed this rule slightly a few years ago, allowing employers to implement a grace period of 2 ½ months after the close of the tax year. For example, if you incurred medical expenses in February, you still could use the funds remaining in a health care FSA from the prior year.
Now the IRS has gone one step further. It says an employer can allow FSA participants to carry over up to $500 of funds left in the account to the following year. But there’s a catch: You can’t use both the grace period and the $500 carryover. It’s one or the other.
Note that the annual limit on contributions to a health care FSA is $2,500, but you can contribute up to $5,000 annually to a dependent care FSA.