How Grace Periods for Flexible Spending Accounts (FSAs) Work

Some employers offer a grace period option for their employees' flexible spending accounts (FSAs). Applicable to both a health FSA and a dependent care FSA, a grace period 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.

Key Takeaways

  • Some flexible spending accounts (FSAs) offer grace periods, at the discretion of the employer sponsoring the plan.
  • The grace period basically allows employees a little more time to spend their unused FSA funds, which normally are forfeit at the end of the year.
  • Grace periods begin the day following the end of the plan year and last for two and a half months.
  • Claims submitted during the grace period are automatically taken out of the prior year's remaining funds before drawing from the current plan year.
  • An FSA grace period is not the same as an FSA carryover provision, which allows you to carry over a certain sum for the next plan year without a time limit of when it has to be used.

What Is an FSA?

An FSA is intended to help employees cover health-related costs that are not included in their insurance plans.

The specifics vary, but such plans generally can be used to help cover a deductible or pay for prescription glasses. Some can be used for alternative treatments like acupuncture. With a doctor's prescription, you may be able to use the FSA to help pay for a gym membership or massage therapy.

First aid products are generally covered, including items like bandages. Many over-the-counter medications and remedies are covered, but only if you have a doctor's prescription for them. These include common products like aspirin, cold medicine, antacids, acne cream, ear wax removers, and wart removers.4

How FSA Grace Periods Work

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 (with exception of 2020 and 2021), the grace period begins Jan. 1 and ends March 15. In 2020 and 2021, the grace period extends for 12 months.

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.

The Consolidated Appropriations Act of 2021 allows for more flexibility when it comes to carrying over unused balances from FSA and dependent care assistance programs in plan years 2020 and 2021, as well as extending permissible grace periods for these plan years. Employers may choose to allow all unused funds to be carried over from 2020 to 2021 and from 2021 to 2022. Employers may also choose to extend the grace period to 12 months (rather than the typical two-and-a-half months). The effect of either decision is the same: all unused funds can be carried over and used throughout the entire year.

FSA Grace Period Example

Imagine, for example, your plan year ends on Dec. 31, 2022. At that point, you still have $150 left in unused funds in your FSA. On Feb. 5, 2023, you incur $400 in eligible medical expenses. After your claim is submitted, the remaining $150 from the 2022 plan is used first for reimbursement, and the other $250 is taken out of the funds from the 2023 plan.

Grace Period vs. Carryover Provision

Employers can provide a grace period or a carryover provision for FSAs, but not both. A carryover provision allows you to carry over a certain sum for the next plan year without a time limit of when it has to be used: That amount is $550 in 2021, rising to $570 in 2022. However, with both the grace period and carryover option, there is still a maximum $2,750 annual contribution limit in 2021, rising by $100 to $2,850 in 2022.

To take advantage of the grace period option, FSA plans must be amended to include the option by the end of the prior year. For example, if you were to have a grace period option for the 2019 year, your employer would need to amend your plan by Dec. 31, 2018, 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.

Article Sources

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  1. Internal Revenue Service. "Health Savings Accounts and Other Tax-Favored Health Plans." Accessed June 18, 2021.

  2. IRS. "2020 Publication 969: Balance in FSA," Pages 16-17. Accessed June 18, 2021.

  3. Internal Revenue Service. "ADDITIONAL RELIEF FOR CORONAVIRUS DISEASE (COVID-19) UNDER § 125 CAFETERIA PLANS." Accessed June 18, 2021.

  4. Internal Revenue Service. "RP-2021-45," Page 14. Accessed Nov. 26, 2021.

  5. IRS. "Pub 20-45." Accessed September 9, 2021.