Is it time to lose the 'use it or lose it' rule for FSAs?

Marcus Pickett

Recently proposed legislation may do away with the "use it or lose it" rule for flexible spending accounts (FSAs). The bipartisan bill (HR 1004) is sponsored by U.S. Reps. Charles Boustany, R-La., and John Larson, D-Conn. If it becomes law, it would allow account holders to cash the funds in their FSAs at the end of the year instead of surrendering them entirely.

FSAs usually are offered as part of employers' group health insurance plans. They allow workers to avoid paying income taxes on money set aside for qualified medical expenses (like orthodontia and eye care). However, if the funds are not used by March 15 of the following calendar year, they are considered forfeited to the employer. This is known as the "use it or lose it" rule.

The rule consistently has been one of the major criticisms of FSAs. There's no question that doing away with the rule would benefit workers who get health insurance through their jobs, but maintaining FSAs may require additional fixes, as the forfeited funds help offset the administrative costs of the program for employers, according to the Society for Human Resource Management.

The limitations of FSAs

FSA users often find themselves with the challenge of contributing enough for medical expenses -- but not so much that they have funds left over at the end of the year. Some buy medical supplies in bulk to avoid losing the funds at the end of the time window. Some avoid enrolling altogether to avoid the risk of losing money. Each of these trends runs counter to the goal of FSAs: Giving health care consumers greater control at a lower cost and improving efficiency in the health care system.

The legislation would not be the only major change that FSAs have seen recently. The health care reform law established contribution limits of $2,500 per year that are set to take effect in 2013. And, as of Jan. 1, 2011, account holders no longer can use FSA funds for over-the-counter drugs unless they first obtain prescriptions for them.

The end of 'use it or lose it'?

Boustany and Larson introduced their bill March 10, 2011. In a letter to their congressional colleagues, they pointed out that more than 85 percent of large employers offer FSAs -- but only 20 percent to 22 percent of employees who are eligible for them enroll.

In a news release about the bill, Boustany argues that the "use it or lose it" provision punishes those who save. Forcing workers to give up the "hard-earned dollars" they set aside, Larson claims, is contrary to the goals of FSAs. Their bill, therefore, would allow leftover funds to be treated as regular taxable wages that the employee could cash out, pay taxes on and keep.
Meanwhile, Save Flexible Spending Plans (an advocacy campaign that supports Boustany and Larson's bill) argues that the annual $2,500 cap that health care reform imposes on FSAs should ease employer's concerns that FSAs would become tax shelters.

Employers, however, argue that these forfeited funds are critical to maintaining the viability of their FSA programs. Along with the typical administrative costs of an employer-sponsored health plan, employers must contend with the "uniform coverage rule," according to the Society for Human Resource Management.

The uniform coverage rule requires that, on the first day of the year, employers make available the full amount that an employee is allowed to contribute over the year. In other words, employees can spend FSA money before they've contributed it. And if an employee then leaves halfway through the year, the employer is unable to reclaim funds that have been spent. Other employees' forfeited FSA funds are used to fill that gap, according to the Society for Human Resource Management.

These proposed changes, therefore, could make FSAs too risky for employers -- and if employers can no longer afford to maintain FSA programs, they might stop offering them altogether.