IRS: FSA cap remains $2,750 for 2021; rollover increases

The IRS announced 2021 adjustments for more than 60 tax provisions, including health FSAs.

Posted November 5, 2020

On October 26, the Internal Revenue Service (IRS) announced the 2021 inflation adjustments for more than 60 tax provisions, including those related to flexible spending arrangements — more commonly called “flex spending accounts” or “FSAs.”

For 2021, the FSA contribution cap remains the same at $2,750 — meaning that’s the most employees may contribute to their FSAs through pretax salary reductions.

Plans that allow employees to carryover unused funds to the following year, however, are seeing a slight increase. The maximum carryover amount for 2021 is increasing to $550, up $50 from 2020.

Generally, employees must use their FSA money within the plan year. Employers, however, may offer one of two options for an extension of unused funds:

  1. Grace Period: Employers may provide a grace period of up to two-and-a-half extra months for employees to use their FSA money (March 15 for calendar year plans).
  2. Carryover: Employers may allow employees to carry over up to $550 in 2021 to use in the following year.

Employers may offer either of these options, but not both. On the other hand, employers are not required to offer either option. Many do, though, as it’s an added benefit for the workforce.

Many employers are in the midst of open enrollment when employees are choosing their 2021 health and benefit plans, so the timing of this announcement is crucial.

What is an FSA?

An FSA is a use-it-or-lose-it health care benefit that many employers offer. At the end of the year (or grace period), employees lose any money that is left in their accounts. Thus, it’s important for employees to plan carefully and not put more money in an FSA than they think they’ll spend on medical expenses within a plan year.

Employees may not fully understand how FSAs work. If employees are fresh out of college and new to the workforce, this might be the first time they’re managing their own health care expenses. They may not realize how to budget and prepare for these costs.

Employees who are in the middle of their careers and who may be raising a family could have different needs than others just starting out. These employees may be able to make the most of their FSA money to cover costly emergency room visits for kids’ sports injuries, eye doctor expenses, and other costs associated with raising a family.

Empty-nester employees may want to reduce their FSA funds. However, reducing their FSA contributions could bump them up into a higher tax bracket, since their take-home pay would increase. They might want to consult with a financial advisor before making any changes.

Basic FSA facts

Sometimes financial information can be confusing — especially when it relates to health care. Here are some basic facts about FSAs:

  • Tax savings. Employees don’t pay taxes on FSA money. This means employees save an amount equal to the taxes they would have paid on the money set aside for health care costs.
  • Employer contributions. Employers may make contributions to employees’ FSAs (but aren’t required to).
  • Fund limits. In 2021, FSAs will be limited to $2,750. Spouses may each have their own FSA fund, but they may not both get reimbursed for the same expense. Funds pay for health care expenses of employees and their spouses or dependents (if applicable). Employees may spend FSA funds on deductibles and copayments, but not on insurance premiums.
  • Fund coverage. Employees may spend FSA funds on health care expenses such as: prescription medications, over-the-counter medicines (with a doctor’s prescription), medical equipment like crutches, supplies like bandages and eyeglasses, blood sugar test kits, and many other items.

FSA funds are a great way to offset health care costs. Employers and employees, however, must know what’s considered an eligible expense and when fund deadlines are.

This article was written by Michelle Higgins of J. J. Keller & Associates, Inc.

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