Flexible spending extension expected to be little-used: Planners say total elimination of use-it-or-lose it rule would increase participation, make plans more useful

September 26, 2005

A new Internal Revenue Service rule relaxes the "use it or lose it" rule in flexible spending accounts by extending the period during which expenses may be incurred beyond the end of the plan year.

Health care flexible spending accounts allow participants to set aside at the beginning of the year a predetermined amount of pretax money to be used for medical, dental and vision expenses not covered by insurance. Dependent care spending accounts do the same thing for child care expenses. While the new rule applies to both types of accounts, its impact likely won't be as big on dependent care accounts because employees are more easily able to determine at the beginning of the year how much they will spend on child care than on health care.

With both accounts, unused money at the end of the plan year is forfeited to the employer, who typically uses the funds to offset administration costs of the program.

A grace period tagged on to the end of the plan year had been available only for the filing of claims that were incurred during the year.

Now, if an employer chooses to adopt the change, participants are given up to an additional 2-1/2 months to incur expenses, such as medical bills or the purchase of glasses, and be reimbursed with funds still unused from the prior year.

The rule, which employers were notified of this spring, is effective for plans that are amended by the end of this year.

While participants have more time to incur expenses and use money they set aside at the beginning of the prior year, many in the benefits industry-who have called for regulations that would allow carryover of unused funds to the next year-consider the new rule a disappointment.

Lack of excitement

"Most vendors and carriers aren't excited about the change," said Bryan Brenner, CEO of locally based Benefit Associations Inc., which advises clients on various benefit plans, including flexible spending accounts. "The only thing it really does is extend the plan year by 2-1/2 months."

Those who used to rush out in December to buy glasses and contact lenses so they could use up their account money will now simply do it in February, he said.

Some insurance companies and benefit administrators have been clamoring for a true carryover of unused money that could be applied to the next year's election. Employees would be more realistic about estimating future health care expenses if they didn't have to worry about the possi bility of losing unspent funds, financial planning experts say.

The new regulation is seen as a way to appease companies and others asking for rollover allowances, Brenner said.

"There was a lot of pressure on regulators to keep employers satisfied," he said.

The IRS did not-and still doesn't-want to allow plans to roll over unused funds because more employees would likely participate in the plans, Brenner opined.

"Tax savings for participants is lost revenue for the government," he said.

An employee's annually elected amount to a flex account is not subject to federal or Social Security taxes, which lowers taxable wages. In most cases, the plans also are not subject to state income tax.

Since an employee's taxable wages are reduced, employers end up paying less in payroll taxes as well.

'Hassle factor'

Brenner does not expect many employers to adopt the change and is, in fact, advising his clients not to do so.

"If they insist on doing it, we're telling them to amend next year, not this year," he said.

That's because the change will also likely cause problems for companies that administer the plans and there is little time between now and the end of the year for companies to adjust their systems to the change.

Since employees can go to the doctor in January 2006 and submit the claim against their 2005 account after having already made an election for 2006, plan administrators have to know which plan year to deduct the money from.

Employees must be allowed to make that determination, so setting up a default would not solve the issue.

And many administrators are using debit cards for reimbursement, which causes more problems, Brenner said.

"Debit cards only know the word 'balance' so they can only pull from whatever the current year is," he said.

Then there's the cost that will likely be experienced by administrators that will have to process claims for two plan years simultaneously-at least for 2-1/2 months.

"It comes down to advantages vs. the hassle factor," Brenner said.

The biggest advantage seems to be that employees may see this as a positive. Companies may adopt the change in an attempt to offer something good at a time when insurance premiums are rising and plan benefits are being cut back.

"Still, the hassle factor makes it not worth it," Brenner said.

He could be right.

In a recent study of 318 employers conducted by the Deloitte Center for Health Solutions and the ERISA Industry Committee, only half said they would extend the grace period for health care flex accounts this year. Only 34 percent plan to extend the grace period to allow participants in both the health care and dependent care accounts to carry over unused money.

Those reluctant to make the change cited concern about tracking account balances for two separate plan years and difficulty in coordinating the grace period with the next year's plan.

Still others say forfeitures have not been a significant problem for employees, and communicating the change could be problematic.

Many of those concerns were expressed by Sandy Reigle, corporate vice president of human resources for locally based Tube Processing Corp.

Tube employs 400, about half of whom participate in the company's health care spending account.

The company was leaning toward adopting the change but decided against it in the end.

"We've already educated [employees] to be responsible and think about the plan a certain way," Reigle said. The change "might create more confusion and undo the good we've done."

While Reigle didn't have forfeiture data handy, he said plan participants are not forfeiting much each year.

"We don't have complaints about forfeitures," he said. "More often, they use it up too soon."

Tube's plan uses a debit card, and coordinating that usage in two plan years seems prone to problems, he said.

Not everyone is quick to nix the potential benefits of the new grace period.

"As with most things, it's neither good nor bad," said Jerry Ripperger, director of consumer health for Des Moinesbased The Principal Financial Group, parent of locally based benefits firm J.F. Molloy and Co.

The change is good because it will likely alleviate fears instilled by the "use it or lose it" clause, thereby boosting enrollment in the plans, Ripperger said.

But because most employers use forfeitures to cover plan administration costs, more participants using all their money will reduce that pool of money, which is a negative, he said.

But that loss will likely be made up in lower payroll taxes as a result of more participants putting money aside.

And the true rollover feature employees want? They'll get that eventually, Ripperger said.

"This is a baby step in getting to a full rollover feature."
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