What Happens to FSA Money if Not Used?

A Flexible Spending Account (FSA) is an employer-sponsored benefit that allows individuals to set aside pre-tax money for eligible healthcare expenses. These funds can be used for out-of-pocket costs such as copayments, deductibles, prescription medications, and vision or dental care. The primary purpose of an FSA is to help participants save on income taxes while managing anticipated medical costs throughout the year. What happens to money not fully spent by the end of the plan year is a common question.

The Forfeiture Rule

The Internal Revenue Service (IRS) generally mandates a “use it or lose it” rule for Flexible Spending Accounts. This rule aims to prevent FSAs from becoming long-term savings vehicles, ensuring they are used for current-year healthcare expenses rather than deferred compensation. The implication for account holders is the necessity to carefully estimate their annual healthcare spending to avoid losing contributions. Employers have several options for how they can utilize these forfeited funds. They may retain the money, or they can use it to offset the administrative costs associated with managing the FSA plan. Alternatively, employers can choose to reduce the required salary deferrals for FSA participants or return the forfeitures to participants on a reasonable and uniform basis. This flexibility for employers is outlined in Treasury Proposed Regulation 1.125-5(o).

The Grace Period Option

Despite the forfeiture rule, employers can choose to offer certain exceptions, one of which is a grace period. This optional provision allows participants an extended timeframe, typically up to 2.5 months, after the end of the plan year to incur new eligible expenses and use the previous year’s FSA funds. For instance, if a plan year ends on December 31, a grace period might extend the spending deadline until March 15 of the following year. During the grace period, funds remaining from the prior plan year are still accessible for qualified medical expenses incurred within this extended window. This feature helps mitigate the impact of the “use it or lose it” rule by giving employees additional time to utilize their account balances. An employer’s decision to offer a grace period applies to all employees enrolled in an FSA on the last day of the plan year.

The Carryover Option

Another common exception to the forfeiture rule is the carryover option, which permits a limited amount of unused FSA funds to be rolled into the subsequent plan year. For plan years beginning in 2025, the IRS has set the maximum carryover limit at $660. This carryover feature is also an optional benefit that employers can choose to implement, but it cannot be offered in conjunction with a grace period; employers must select one or neither. Any funds exceeding the IRS-determined carryover limit remain subject to forfeiture at the end of the plan year. Importantly, any funds carried over do not count against the employee’s maximum contribution limit for the new plan year.

Employer Decisions on Unused Funds

The specific outcome for unused FSA money, whether it is forfeited, subject to a grace period, or carried over, is solely determined by the individual employer’s plan design. Employers have the discretion to choose which of these IRS-permitted options, if any, they will offer to their employees. This choice is typically outlined in the company’s benefits documentation or plan summary. Employees should consult their specific plan documents or contact their human resources or benefits department to understand the rules applicable to their Flexible Spending Account. Employers might opt for a grace period or a carryover to enhance employee benefits and retention, providing greater flexibility in managing healthcare costs and reducing the pressure to spend down balances by year-end.