Rules Eased for Health FSAs
Recent changes announced by the Internal Revenue Service (IRS) modify the “use-it-or-lose-it” rule that applies to health flexible spending arrangements (FSAs). Plan sponsors will now have the option of allowing participants in health FSAs to carry over up to $500 of unused funds in a health FSA to the following plan year.
Background
Health FSAs are tax-advantaged employer-provided benefit plans that employees can use to pay for qualifying medical expenses. While generally funded through voluntary employee salary reductions, employers are able to contribute as well. Prior to the start of a plan year, employees decide how much to contribute to the health FSA (the maximum annual employee contribution to a health FSA that is part of a cafeteria plan is $2,500 for 2014). Contributions to the plan are excluded from income for federal income tax purposes, as are any reimbursements made from the plan for qualified medical expenses, including co-payments, deductibles, and dental and vision care expenses.
Any funds left unspent in the health FSA at the end of the plan year are forfeited–this is commonly referred to as the “use-it-or-lose-it” rule. Plan sponsors have the option of providing for a grace period of up to 2½ additional months after the end of the plan year (e.g., a calendar year plan might cover expenses incurred through March 15).
New rules
In Notice 2013-71, the IRS modified the “use-it-or-lose-it” rule that applies to health FSAs:
Plans may now be amended to allow participants to carry over up to $500 of unused health FSA funds at the end of a plan year.
Any carryover will not count against the $2,500 limit in the next plan year.
A plan may allow participants a grace period, as described above, or the ability to carry over unused funds–but not both.
A plan does not have to allow either the grace period or the carryover option.
To adopt the carryover option, plans must be amended on or before the last day of the plan year from which amounts may be carried over, and may be retroactive to the first day of the plan year, provided certain requirements, including participant notification, are met.
Special rules apply to plan years beginning in 2013–these plans may be amended to retroactively adopt the carryover provision at any time on or before the last day of the plan year that begins in 2014.
Word of caution
A health FSA plan can’t have both a grace period and a carryover option, so plans with existing grace periods will have to be amended to remove the grace period feature in order to add carryovers. Plan sponsors should consult carefully with a benefit specialist before taking any action, however, as eliminating an existing grace period feature raises potential issues relating to the Employee Retirement Income Security Act of 1974 (ERISA). IRS Notice 2013-71 itself states that “the ability to eliminate a grace period provision previously adopted for the plan year in which the amendment is adopted may be subject to non-Code legal constraints.”
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Reverse Mortgage Changes
Several changes have been made to the federally insured Home Equity Conversion Mortgage (HECM) reverse mortgage program to shore up the viability of the program. The changes are generally designed to improve the odds that homeowners taking out a reverse mortgage will be able to meet their obligations and not become a burden on the program. The changes are generally effective for new reverse mortgages after September 30, 2013 (but prior rules generally apply to case numbers assigned before September 30, 2013, if closed on or before December 31, 2013). Additional financial assessment and set-aside requirements take effect January 13, 2014.
Initial disbursements limited
One change generally restricts the amount that can be disbursed to you within one year of your obtaining the reverse mortgage. Under the new rules, the maximum amount that can be disbursed to you at closing or during the first 12-month disbursement period is equal to the greater of (a) 60% of the principal limit or (b) the sum of your mandatory obligations plus 10% of the principal limit (not to exceed 100% of the principal limit). Mandatory obligations include items such as the initial mortgage insurance premium, the loan origination fee, recording fees and taxes, credit reports, a survey, a title examination, title insurance, a property appraisal fee, fees for warranties or inspections, funds to pay any required repairs, and amounts used to discharge liens, debt, and taxes. Except in the case of a single disbursement lump-sum payment option, additional amounts can be disbursed in later years, up to 100% of the available principal limit.
New mortgage insurance premium rates
Another change increases the basic initial mortgage insurance premium, and applies an even higher rate if more than 60% of the principal limit can be disbursed to you in the first year. Under the new rules, an initial mortgage insurance premium fee of 0.5% of the maximum claim amount will generally be charged. The initial fee is increased to 2.5% of the maximum claim amount if required or available disbursements to you at closing or during the first 12-month disbursement period are greater than 60% of the principal amount. In either case, there is also an annual fee equal to 1.25% of the mortgage balance.
Financial assessment and set-asides
Finally, changes are made to improve the odds that you will be able to meet certain of your obligations under the reverse mortgage. For case numbers assigned on or after January 13, 2014, you must undergo a financial assessment prior to approval and closing on a reverse mortgage. Based on your assessment and as a condition of loan approval, you may be required to use proceeds from the reverse mortgage to fund a lifetime expectancy set-aside for payment of property charges or authorize the mortgagee to pay property charges from your monthly payments or your line of credit. Property charges include property taxes, hazard insurance, and flood insurance.
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