Are mid-year exceptions permitted?
An employee wants an exception to enroll his child in the plan mid-year without experiencing a permitted election change event. What are the specific issues preventing this?
Compliance Team Answer:
There are three main issues to consider when considering this type of a plan exception:
- The Section 125 Cafeteria Plan Rules;
- The Insurance Carrier Policy Limitations; and
- The ERISA Plan Precedent.
Below is a summary of each of these three concerns, and why we recommend not making an exception.
- Section 125 Cafeteria Plan
Employees’ elections to pay the employee-share of the premium for coverage on a pre-tax basis are governed by Section 125 of the Internal Revenue Code. The Section 125 cafeteria plan rules are very strict when it comes to the irrevocability of employees’ elections.
That general rule under Section 125 is that all elections (including an election not to participate) must be: 1) made prior to the start of the plan year (or within 30 days of becoming eligible mid-year), and 2) irrevocable for the plan year unless the employee experiences a permitted election change event. The permitted election change events are set forth in Treas. Reg. §1.125-4 (e.g., marriage, divorce, birth, adoption, change in employment status affecting eligibility). See attached (here) for a more detailed summary of these events.
Failure to adhere to these limited list of events or the 30-day time restriction to make the election change imposed by the plan document can cause the entire cafeteria plan to be disqualified and lose its tax-advantaged status for all employees. This would result in all elections becoming taxable to all employees.
In this case, the employee is requesting to enroll a child mid-year and without experiencing a mid-year permitted election change event. If the company were to permit an exception to allow this employee to enroll the child mid-year without experiencing a permitted election change event (or outside of the required election timeframe for such an event), it would not have a basis for permitting the employee-share of the premium for such coverage to be paid on a pre-tax basis.
This means that the employee would need to pay the employee-share of the premium for the dependent’s coverage on an after-tax basis outside the cafeteria plan for the remainder of the plan year (or until experiencing a mid-year permitted election change event).
- Insurance Policies
The insurance carriers will pay claims only for employees and dependents who are eligible and properly enrolled pursuant to the terms of the applicable insurance policy. The insurance carriers generally will permit employees to enroll only at open enrollment, in the new hire 30-day window, or upon the employee experiencing a permitted election change event and making an election within the required timeframe.
If the insurance carrier (or stop-loss carrier for self-insured) were ever to discover that an employee was permitted to change his or her election to enroll a dependent outside of a permitted election change event (or outside the required timeframe to make an election change), the carrier would be within its right to deny paying all claims for that employee from the date of the election change. That would make the employer responsible for self-funding all claims incurred during the period at issue.
Accordingly, it is crucial that the insurance carrier agree to an exception for the mid-year enrollment if the company wishes to make an exception in this situation. The carrier would be well within its right to deny the change.
Under ERISA, employers are required to administer the plan in accordance with the terms of the written plan document. The plan document will not permit an employee to make an election change unless he experiences a permitted election change event and makes the election within the required timeframe.
If the employer makes an exception, it effectively acts as a plan amendment that must be applied consistently for all similar situated employees. In other words, exceptions create an ERISA plan precedent requiring the plan to permit election changes for all employees in similar circumstances who wish to change their election for the same reason. An employee denied the ability to change his or her election in similar circumstances would have a claim for ERISA breach of fiduciary duty or claim for benefits.
The plan precedent established in this scenario would likely require that the company offer all employees the ability to enroll dependents in the plan mid-year (and without experiencing a permitted election change event). We believe that would create a very difficult plan precedent to manage.
For all of the reasons described above, we recommend not permitting the employee to enroll the child mid-year (without a permitted election change event). If the company wishes to permit the exception nonetheless, we suggest carefully considering each of the three issues described above before proceeding.
I’ve copied a few of the relevant cites below for your reference. Let’s discuss if there are any questions.
Prop. Treas. Reg. §1.125-1(c)(7):
(7) Operational failure.
(i) In general. If the cafeteria plan fails to operate according to its written plan or otherwise fails to operate in compliance with section 125 and the regulations, the plan is not a cafeteria plan and employees’ elections between taxable and nontaxable benefits result in gross income to the employees.
(ii) Failure to operate according to written cafeteria plan or section 125. Examples of failures resulting in section 125 not applying to a plan include the following—
(A) Paying or reimbursing expenses for qualified benefits incurred before the later of the adoption date or effective date of the cafeteria plan, before the beginning of a period of coverage or before the later of the date of adoption or effective date of a plan amendment adding a new benefit;
(B) Offering benefits other than permitted taxable benefits and qualified benefits;
(C) Operating to defer compensation (except as permitted in paragraph (o) of this section);
(D) Failing to comply with the uniform coverage rule in paragraph (d) in §1.125-5;
(E) Failing to comply with the use-or-lose rule in paragraph (c) in §1.125-5;
(F) Allowing employees to revoke elections or make new elections, except as provided in §1.125-4 and paragraph (a) in §1.125-2;
(G) Failing to comply with the substantiation requirements of § 1.125-6;
(H) Paying or reimbursing expenses in an FSA other than expenses expressly permitted in paragraph (h) in §1.125-5;
(I) Allocating experience gains other than as expressly permitted in paragraph (o) in §1.125-5;
(J) Failing to comply with the grace period rules in paragraph (e) of this section; or
(K) Failing to comply with the qualified HSA distribution rules in paragraph (n) in §1.125-5.
Prop. Treas. Reg. §1.125-2(a):
(a) Rules relating to making and revoking elections.
(1) Elections in general. A plan is not a cafeteria plan unless the plan provides in writing that employees are permitted to make elections among the permitted taxable benefits and qualified benefits offered through the plan for the plan year (and grace period, if applicable). All elections must be irrevocable by the date described in paragraph (a)(2) of this section except as provided in paragraph (a)(4) of this section. An election is not irrevocable if, after the earlier of the dates specified in paragraph (a)(2) of this section, employees have the right to revoke their elections of qualified benefits and instead receive the taxable benefits for such period, without regard to whether the employees actually revoke their elections.
(1) Every employee benefit plan shall be established and maintained pursuant to a written instrument. Such instrument shall provide for one or more named fiduciaries who jointly or severally shall have authority to control and manage the operation and administration of the plan.
Disclaimer: The intent of this analysis is to provide the recipient with general information regarding the status of, and/or potential concerns related to, the recipient’s current employee benefits issues. This analysis does not necessarily fully address the recipient’s specific issue, and it should not be construed as, nor is it intended to provide, legal advice. Furthermore, this message does not establish an attorney-client relationship. Questions regarding specific issues should be addressed to the person(s) who provide legal advice to the recipient regarding employee benefits issues (e.g., the recipient’s general counsel or an attorney hired by the recipient who specializes in employee benefits law).