Question

My employer forwarded to me an update regarding our company’s flexible spending account plan. It indicates that the plan’s “use it or lose it” rule will be modified. In 2003, I lost some of the money that I put into my account because I did not use it all by December 31 st of that year. My employer refused to make an exception for me so I have stopped contributing to the plan. Could my employer have made an exception for me in 2003? If not, why are they able to do so this year?

Answer:

A flexible spending account is an employer-sponsored savings plan that allows employees to set aside a certain amount of money each year on a pre-tax basis, and then use that money to pay for certain medical bills and expenses. These accounts can also be used to purchase medical supplies and over the counter drugs including aspirin and Band-Aids and, depending on the plan, they cover the cost of smoking cessation programs, weight loss programs, and alcohol or drug addiction treatments. The main benefit of these accounts is tax savings. Because these accounts permit employees to pay for medical expenses on a pre-tax basis, employees can save the amount of tax they would normally pay on the income they defer into the flexible spending account.

On May 18, 2005, the Internal Revenue Service announced a modification to the flexible spending account “use it or lose it” rule. The “use it or lose it” rule had required that participants spend the money in their flexible savings account by the end of the plan year or forfeit the remaining balance. Under the new rule, flexible spending account plan sponsors, i.e. employers, have the option to modify their flexible spending account plans to allow up to 2 ½ months after the end of the plan year for participants to incur the expenses to be reimbursed out of the prior year’s flexible spending account. Prior to May 18, 2005, employers did not have that option, and that is why your employer could not make an exception for you in 2003.

Employers are not required to offer their employees flexible spending account plans but many do. Also, employers are not required to amend their plans to allow employees an extra 2 ½ months to incur reimbursable expenses. However, studies have shown that the “use it or lose it” rule is the top reason why employees with access to these plans do not utilize them. Hopefully, this relaxation of the rules will result in greater employee participation, which will lead to increased tax savings for both employees and employers.
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