On May 18th, the IRS announced that employers can amend their reimbursement accounts in cafeteria plans to add a grace period of up to 2-1/2 months after the end of the plan year during which participants can incur eligible expenses. This may reduce forfeitures for participants who overestimate their expenses for the 12-month plan year. Here is a link to IRS Notice 2005-42: http://www.treas.gov/press/releases/reports/n0542.pdf.
Summary of New Use-It-Or-Lose-It RuleNew rule applies to both health care and dependent care reimbursement accounts. However, it is more likely to have practical significance to health care reimbursement accounts.
Plan must be amended if the employer wants to adopt the new rule.
Grace period can be applied to 2005 elections. If the plan is amended before the end of its plan year (i.e., December 31, 2005 for calendar year plans), participants can be reimbursed for claims incurred during the new grace period with respect to their current elections.
Change must apply to all participants.
Maximum grace period is 2-1/2 months. A shorter grace period is permissible.
Account balances remaining at the end of the grace period are forfeited. The use-it-or-lose-it rule still applies to any amounts not used at the end of the plan year plus grace period.
"Run-out" period for filing claims is still permitted. Many current cafeteria plan designs permit participants to submit requests for reimbursement until March 15 of the year following the plan year in which the expenses were incurred. The new use-it-or-lose-it rule allows employers to continue to provide such a run-out period that would follow the end of the grace period.
Summary of New Use-It-Or-Lose-It Rule
- Change is optional.
Reasons to Add the Grace Period
- Employees will like the new rule. The new rule will result in less participant forfeitures since participants will have more time to "spend" their account balances.
- Tax savings if participation in health care and dependent care reimbursement programs increases. The new rule may attract more participants to health care and dependent care reimbursement programs because they will worry less about overestimating the amount of expenses they will incur during the plan year. Increased participation by employees in these pre-tax benefits means that the employer may realize FICA and FUTA savings.
Reasons Not to Add the Grace Period
- Less forfeitures may be available to employers to defray reasonable administrative expenses of the health care or dependent care reimbursement program.
- Overlap between grace period at the end of one plan year and the beginning of next plan year may be more difficult to administer. Employers will need to consult with third-party administrators and internal financial accounting staff to determine what record keeping and accounting problems a grace period could present.
- May be difficult to communicate to employees. Employees will need to understand how the grace period works so they can adjust future elections. For example, if they expect to use expenses incurred during the grace period to spend down the prior year’s account, they may need to lower the level of their contributions for the next year. In addition, employers with high deductible health plans will need to consider the impact of the grace period on the ability to contribute to a Health Savings Account (an issue not addressed in the IRS Notice).
Action Items to Amend Cafeteria Plan’s Use-It-Or-Lose-It Rule
- Discuss implementation with third-party administrator and internal financial accounting department.
- Determine whether to implement new rule.
- Prepare communication to employees.
- Adopt plan amendment prior to the end of the plan year for which new rule is to be effective and distribute summary of material modifications or updated summary plan description unless employee communication serves that purpose.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
We operate a free-to-view policy, asking only that you register in order to read all of our content. Please login or register to view the rest of this article.