Is your workplace FSA overfunded or underfunded due to the impact of COVID-19? The Internal Revenue Service has come up with a partial fix to the mess of so-called “flexible” spending arrangements that let workers stash pre-tax money into special accounts for healthcare and child care. The rules surrounding FSAs are anything but flexible. Typically you choose how much money to put into these accounts from your paycheck in the fall, predicting what your expenses will be for the next calendar year, and then you take money out to cover eligible expenses, so you come out ahead taxwise. But the problem is you’re usually guessing what your expenses will be. You can lose out by overestimating or underestimating expenses. Most plans have a $500 carryover, but otherwise, if you don’t spend down the account, you lose what’s leftover.
The COVID-19 pandemic has made it clear that this whole matter of guessing a year ahead of time isn’t a reasonable approach to managing healthcare or child care expenses. What if you put away $2,000 thinking you were going in for elective surgery and now it’s postponed? Or maybe your healthcare spending needs have gone up because of COVID-19. What if you have child care expenses because schools are closed? Or maybe your child’s camp isn’t running.
You can sign up anew, revoke or change how much pre-tax money you’re stashing in workplace savings accounts for healthcare and child care, the Internal Revenue Service announced today. That’s good news for workers whose healthcare and child care needs have changed since COVID-19 struck.
The IRS Notice 2020-29 allows for mid-year changes to employer-sponsored health care coverage, healthcare FSAs and dependent care accounts. The new rules for 2020 will help workers who made what turned out to be bad choices when funding these accounts last fall. The new rules also allow changes to your health care plan.
Here are the major changes allowed:
- Make a new election for employer-sponsored health coverage on a prospective basis if you initially declined coverage
- Make changes to your health coverage (for example, change from individual to family coverage, or change from one type of plan to another)
- Revoke coverage on a prospective basis, if you confirm in writing that you’ll get coverage elsewhere
- Revoke an election, make a new election, or decrease or increase an existing election regarding a healthcare FSA on a prospective basis
- Revoke an election, make a new election, or decrease or increase an existing election regarding a dependent care account on a prospective basis.
It’s up to employers to decide whether to allow these changes, but most should as they’ve been implementing other COVID-19 employee benefits relief such as making it easier to take loans and distributions from 401(k) retirement plans (here’s why taking a 401(k) distribution is safer than taking a loan).
The IRS Notice says that employers are not required to provide unlimited changes, so think through the changes you want to make. It may be a one time opportunity. And it’s better to act sooner rather than later if you’re in the overestimating group. For money that’s already been taken out of your paychecks to fund these accounts so far this year, there’s no backsies. The relief is only going forward.
One reason you may want to put more in your healthcare FSA is that the COVID-19 stimulus package permanently expanded the list of eligible items for reimbursement to include menstrual products (i.e. tampons) and over-the-counter medications that used to required a doctor’s prescription. That’s more stuff that you can buy with pre-tax dollars, meaning tax savings on a trip to the drugstore.
One thing that could help is that the Notice also extends “grace periods” and “carry-overs” through year-end. Most plans let you carry over $500 from the prior plan year to spend in the beginning of the next plan year. The Notice increases the $500 carryover to $550, and essentially extends the time to file claims for reimbursement through the plan’s year-end 2020 (that’s Dec. 31, 2020 for most plans, but believe it or not, it’s June 30, 2021 for some plans on a split calendar year system).
Here’s an example pulled from the IRS Notice that shows how insanely complicated this is:
Example 1. Employer provides a health FSA under a § 125 cafeteria plan that allows a $500 carryover for the 2019 plan year (July 1, 2019 to June 30, 2020). Pursuant to this notice and Notice 2020-33, Employer amends the plan to adopt a $550 (indexed) carryover beginning with the 2020 plan year, and also amends the plan to adopt the temporary extended period for incurring claims with respect to the 2019 plan year, allowing for claims incurred prior to January 1, 2021, to be paid with respect to amounts from the 2019 plan year. Employee A has a remaining balance in his health FSA for the 2019 plan year of $2,000 on June 30, 2020, because a scheduled non-emergency procedure was postponed. For the 2020 plan year beginning July 1, 2020, Employee A elects to contribute $2,000 to his health FSA. Employee A is able to reschedule the procedure before December 31, 2020 and, between July 1, 2020 and December 31, 2020, incurs $1,900 in medical care expenses. The health FSA may reimburse Employee A $1,900 from the $2,000 remaining in his health FSA at the end of the 2019 plan year, leaving $100 unused from the 2019 plan year. Under the plan terms that provide for a carryover, Employee A is allowed to use the remaining $100 in his health FSA until June 30, 2021, to reimburse claims incurred during the 2020 plan year. Employee A may be reimbursed for up to $2,100 ($2,000 contributed to the health FSA for the 2020 plan year plus $100 carryover from the 2019 plan year) for medical care expenses incurred between January 1, 2021 and June 30, 2021. In addition, Employee A may carry over to the 2021 plan year beginning July 1, 2021 up to $550 of any remaining portion of that $2,100 after claims are processed for the 2020 plan year that began July 1, 2020. A grace period is not available for the plan year ending June 30, 2021.
The bottom line is you’ll have to contact the administrator for your health care plan or FSA to make changes. Put more money in for 2020 if you’re pretty sure you’ll have expenses to match. Stop making contributions if you think your expenses will be lower than you predicted.
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