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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.
example, a plan might allow participants until April 15, 2006 to submit claims for
the period ended March 15, 2006.
for a different 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.
