In a significant modification of the nearly 30-year-old “use it or lose it” rule, employers will be allowed to modify flexible spending accounts to permit employees to carry over to the following year up to $500 in unused account balances, the U.S. Treasury Department and the Internal Revenue Service said Thursday.

“Across the administration, we are always looking for ways to provide added flexibility and common-sense solutions to how people pay for their health care,” Treasury Secretary Jacob J. Lew said in a statement. “Today's announcement is a step forward for hard-working Americans who wisely plan for health care expenses for the coming year,” he added.

The Treasury/IRS announcement comes more than a year after regulators disclosed that that they were considering modifications to the 29-year-old rule that requires plan participants to either forfeit unused balances at the end of a plan year or, if the employer has adopted one, at the end of a grace period.

Under the grace period, unused account balances can be carried over and can be used to pay health care expenses incurred in the first 2½ months of the next plan year.

In modifying the use-it-or-lose-it rule, the Treasury Department said the change will reduce “wasteful” FSA spending.

The modification “cuts back on wasteful year-end FSA health care spending by limiting the risk of forfeiture and in turn reducing the incentive to spend down as year-end approaches in order to avoid the losing unused funds,” the Treasury Department said.

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However, the Treasury Department did attach a condition to the easing of the use it or lose it rule.

Employers will have a choice of either allowing employees to carryover up to $500 or offering the 2½-month grace period.

“Employers will welcome the new option to allow employees to carry over amounts in their health FSA but will have to choose between the carryover and a grace period,” said Amy Bergner, managing director of human resource solutions at PricewaterhouseCoopers L.L.P. in Washington.

Others were disappointed that regulators placed a cap on permitted rollovers.

“It would be a lot smoother if remaining balances, whatever their size, could be rolled over to the next year,” said Andy Anderson, a partner with Morgan, Lewis & Bockius L.L.P. in Chicago.

Still, employers welcome the modification.

“Our initial reaction of surprise has morphed into pleasure. We have waited for this change for a long time,” said Gretchen Young, senior vice president of health policy at the ERISA Industry Committee in Washington.

“This is welcomed and great news for millions of workers and their families,” said Helen Darling, president of the National Business Group on Health in Washington.

An estimated 14 million American families now participate in health care FSAs, the Treasury Department said.