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THE NEW USE IT OR LOSE IT RULE FOR CAFETERIA PLANS
George L. Chimento
May, 2005
Use it or lose it,” is the infamous principle of Section 125 flex/cafeteria plans. Positive
account balances traditionally cause a December stampede to purchase eyeglasses and
other medical what-nots. The expenses must be incurred by December 31 or the balance is
forfeited to the employer.
For a country that wants to contain medical expenses, the rule that 125 savings must be
spent or forfeited is a little silly. IRS has issued some welcome relief with new Notice 2005-
42.
Starting with 2005, a cafeteria plan can now honor expenses incurred within two and one-half
months following the end of the year. “Use it or lose it” remains the law, but a claims period
of fourteen and one half months will provide a bit of relief.
Example:
- Jill has a $100 positive account on December 31, 2005. It will not be forfeited on
December 31 if the 125 plan is amended for this new rule. The $100 can be used for
expenses incurred through March 15, 2006. The $100 will be spent before any
expenditure of 2006 deferrals. If it is not spent, it will be forfeited on March 16, 2006.
might allow participants until April 15, 2006 to submit claims for the period ended March 15,
2006.
purpose. For example, a healthcare account surplus cannot be used for dependent care.
Remember. You can only use this new rule for 2005 if your cafeteria plan is amended by
December 31, 2005. You should leave enough time to communicate the new rule to
participants.
This may not be relied upon as legal advice, or to avoid taxes and penalties. Any
communication with the author as to its contents, does not, of itself, create a lawyer-client
relationship. Distribution to promote, market, or recommend any arrangement or investment
to avoid or evade taxes, including penalties, is expressly forbidden. Under the ethical rules
applicable to lawyers in some jurisdictions, this may be considered advertising.
