Some employers offer the grace period option for their employee's flexible spending account (FSA). The grace period is applicable to a health FSA and a dependent care FSA. It begins the day following the end of the plan year and lasts for two and a half months. It is designed to allow employees the opportunity to take full advantage of their non-taxable contributions when expenses fall short of what was originally projected.

In light of the COVID-19 pandemic, Congress passed the Consolidated Appropriations Act, 2021 that offers more discretion for FSA and dependent care assistance programs. The Act allows for more flexibility when it comes to carrying over unused balances from plan years 2020 and 2021, as well as extending permissible grace periods for these plan years.

FSA Grace Periods

Any eligible medical expenses accrued during this grace period can be reimbursed with funds remaining in the FSA from the prior plan year. The inclusion of the grace period extends the plan year to 14 months and 15 days as opposed to the 12-month actual plan. For calendar year plans, the grace period begins Jan. 1 and ends March 15.

All funds remaining in the account at the end of the grace period are forfeited according to the "use-it-or-lose-it" rule, which requires all remaining funds in an FSA to be forfeited at the end of the plan year. Claims submitted during the grace period are automatically taken out of the prior year's remaining funds before drawing from the current plan year; however, in the event that a debit card is used for eligible expenses, the funds are drawn from the current plan year.

FSA Grace Period Example

Imagine, for example, your plan year ends on Dec. 31, 2020. At that point, you still have $150 left in unused funds in your FSA. On Feb. 5, 2021, you incur $400 in eligible medical expenses. After your claim is submitted, the remaining $150 from the 2020 plan is used first for reimbursement, and the other $250 is taken out of the funds from the 2021 plan.

Grace Period vs. Carryover Provision

Employers can provide a grace period or a carryover provision but not both. A carryover provision allows you to carry over up to $500 for the next plan year without a time limit of when it has to be used. However, with both the grace period and carryover option, there is still a maximum $2,500 annual contribution limit.

To take advantage of the grace period option, FSA plans must be amended to include the option by the end of the prior year. If you were to have a grace period option for the 2021 year, your employer would need to amend your plan by Dec. 31, 2020 for a calendar year plan. Plans cannot be altered mid-year to include the grace period.

It is important to remember that you have until March 15 of the following year to incur eligible expenses, but claims can be submitted for reimbursement up until March 31. This 16-day window is known as the run-out period. After the run-out period expires, all unused funds are forfeited.