A little-noticed bulletin from the Treasury Department could have a big impact on the roughly 155 million Americans who use flexible spending accounts to cover out-of-pocket health care expenses.
The government's notice, sent out in May, included a surprise in what otherwise might have been a dry announcement on the implementation of President Obama's health care reform law. In addition to detailing a new spending cap, the federal government asked for comment on whether it should scrap the “use it or lose it” rules associated with the tax-free health care spending accounts known as FSAs.
FSA accounts allow workers to set aside pretax dollars from their paychecks to pay for approved health care expenses, such as eyeglasses, braces and doctor visit co-pays. Republicans have sought to encourage such accounts based on the view that having consumers take on more out-of-pocket expenses would increase competitive pressures in the health care market and bring down costs. FSAs, however, were targeted twice in Democrats’ health reform law, partly to help cover the cost of the law. The Affordable Care Act restricted FSAs from covering over-the-counter drugs unless users have a doctor’s prescription. It also capped the total contributions people can make to the accounts at $2,500.
But the new restrictions might result in the end of what is often considered one of the most burdensome restrictions on FSA accounts: employees must spend all of the money they put aside for health purchases before the end of the year or forfeit that balance to their employer.
Known as the “use it or lose it” rule, it is one of the top reasons cited by people who decline the option of setting up FSAs. According to Mercer Health & Benefits, a benefits consulting firm, 85 percent of large employers offer FSAs, but only 22 percent of employees participated in 2011. Nearly half of employees surveyed by Evolution1, a software company that specializes in helping companies administer FSA benefits, lost between $100 and $1,000 over the course of one year.
And nothing irks people more than the thought of losing money to their employers. Just ask Susan Kline, a taxpayer from North Carolina who submitted comments to the IRS urging them to end the FSA rule.
“At this point this year, it looks like I may have set too much aside for the year. My husband went on Medicare for the first time this year and I did not anticipate that our costs would go down as much as they did. Unless something unforeseen happens this year, I will end up losing some of my hard-earned money,” Kline wrote. “This whole FSA system of ‘use it or lose it’ is so unfair.”
That rule was originally established to make sure people didn’t use the accounts as a way to shield their income from taxes. But a new cap of $2,500 set to take effect in 2013 would prevent people from using the accounts as big tax shelters. So now the Internal Revenue Service and the Treasury want to know if they should change the FSA “use it or lose it” rule to “provide a different form of administrative relief.”
That relief could come in a number of different forms. Bipartisan legislation from Sens. Ben Cardin, D-Md., and Michael Enzi, R-Wyo., and Reps. Charles Boustany, R-La., and John Larson, D-Conn., would allow employees to collect whatever money is left over in their accounts in the end of the year, up to $500. But Treasury and the IRS could take a number of different approaches, including letting employees roll over funds from one year to the next, or extending a grace period for spending left-over funds into the next calendar year.
Comments on the potential rule change from Treasury and the IRS are due Aug. 17. So far, the IRS has only received seven comments, mostly from ordinary citizens who filled out a form on the “Save Flexible Spending Plans” website. Despite the lack of interest in voicing an opinion (although some people may wait until just before the deadline to comment), Employee Benefit Research Institute senior research Paul Fronstin says getting rid of the “use it or lose it” rule would be a big deal.
“It will definitely have a significant impact,” Fronstin said in an interview. “One of the criticisms of employer benefits coverage is that it is rich, but that’s changed in the last few years. It’s only recently that employers have tried to get into higher cost-sharing as a way to engage people, and to the degree you can pay that cost-sharing from pretax dollars, it insulates people.”
Out-of-pocket costs have steadily grown for employees getting insurance from their jobs. According to the Kaiser Family Foundation, 31 percent of people getting insurance from their employers had deductibles of $1,000 or higher, up from just 10 percent in 2006. An FSA could help reduce the cost of covering those deductibles or co-pays.
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