Definition of FSA Grace Period
A flexible spending account (FSA) grace period, or extension, is 1 of 2 alternate options a business’ plan administrator has to offer plan participants. The extension lasts 2.5 months (typically until March 15), allowing participants to submit and be reimbursed for expenses incurred during the previous plan year. Not all plans offer this option, which is not required by the IRS.
Note: Although there was temporary legislation passed as a result of the pandemic that made exceptions to these parameters, it has expired as of the end of plan year 2021. There are still expenses from 2021 that can be claimed into 2022 as part of that legislation.
What is an FSA grace period?
First, let’s define what an FSA is. FSA stands for Flexible Spending Account. It is a pretax payroll benefit associated with Health, Dependent, and Elderly care. Some employers also offer spending accounts related to parking and commuting expenses.
FSAs can only be elected during a benefits enrollment period. They cannot be changed during the year without the participant experiencing a qualified status change such as:
- Marriage
- Divorce
- Adding or losing dependents
FSA extensions are not a uniform decision across all FSA plans. As plans are developed and documented, FSA administrators have 3 options:
- Not allow exceptions to the normal use it by the end of the plan year or lose it parameters.
- Define an exception that allows the rollover of any unused funds to the new plan year instead of only allowing the rollover amount based on the IRS cap of $570.
- Define an exception allowing plan participants to request reimbursement for expenses incurred during the associated plan year for an additional 2.5 months into the new plan year.
Not all portions of FSA plans are eligible for these options. For example:
- The rollover option is only available for Healthcare FSAs
- The extension option is available for Healthcare, Child Care, and Elder Care FSAs
These exceptions to the standard IRS rules require documentation in the plan document before the plan’s inception.
Why is an FSA grace period important to my business?
FSA grace periods are a valuable option for your business because there are many instances when employees may incur eligible reimbursable expenses through the last day of the plan year. Suppose the plan document doesn’t allow reimbursement requests after the plan year’s end. In that case, employees may lose the funds they had deducted from their paycheck for their health care savings account.
One benefit of offering an extension rather than an all-inclusive rollover is that it requires less administrative work to ensure the total amount of the funds from the previous year are used before any current-year plan deductions are distributed.
Another benefit is that it helps employees more effectively and accurately plan for their annual eligible expenses.
There are no laws requiring businesses to offer FSAs to their staff. Still, employees and employers benefit when workers save money in flexible spending accounts. Because the funds are pretax dollars, businesses save 7.65% on tax and FICA contributions for every dollar deposited into the accounts.
What is the history of the FSA grace period?
FSAs were established in the 1970s in response to increased living expenses brought about by significant inflation. In fact, the Revenue Act of 1978 clarified the benefits and limits associated with health and dependant care FSA plans.
The intent was to allow workers to set aside pretax funds to care for medical expenses they anticipated incurring during the year.
As the workforce grew and the FSA concept matured, the IRS published new guidance in 2007. This new information allowed for a “grace period” permitting participants of qualified FSA benefit plans to submit expenditures incurred during their plan year for 2.5 months after the end of that same plan year. That grace period is what, in today’s vernacular, is commonly referred to as an extension.
Over the years, there have been changes to what expenses the IRS considers eligible and ineligible for FSA reimbursement. Some examples of qualified expenses include:
- Copays
- Medical equipment such as CPAPs, Walkers, and Wheelchairs
- Prescription drugs
Examples of ineligible expenses would be items such as:
- Insurance premiums
- Massages (unless ordered by a doctor and verified by a physician’s written prescription)
- Over-the-counter care (unless it’s required via a doctor’s note)
Because this list is reviewed annually, you can find a current representation on the FSAFEDS site.
Other terms similar to FSA grace period that can help you
- Plan administrator: The individual or company responsible for managing and overseeing a specific benefit plan.
- Plan document: A written legal document that governs how a program is implemented, managed, and administered.
- Dependent: Any person — such as a spouse or child — who is covered under the primary insured’s plan.
Summary of the FSA grace period
An FSA extension or grace period is 2.5 months, during which a plan administrator may include in the company’s FSA qualified document at the beginning of a new plan year as a viable option. This allows participants to submit expenses incurred during the plan year for up to two-and-a-half months into the administration of the new plan year.
Not all FSA plans offer this option.
Similar glossary terms you must know
- Flexible spending account
- Pretax contributions: Contributions that are deducted from the employee’s wages before payroll taxes are taken out. Pretax contributions reduce the employee’s taxable wages.
- Copayment: The fixed amount (e.g., $20) a person pays for a covered healthcare service, generally at the time service is rendered.
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