Question: When an employee experiences a mid-year permitted election change event, when do the employee’s new health and welfare plan elections take effect?

Short Answer: A mid-year election change will typically be effective as of the first of the month following the election change request to avoid the Section 125 cafeteria plan issues associated with paying for retroactive coverage. The primary exceptions are for new hires (elections may be retroactive to the date of hire) and newly born/adopted children (medical coverage must be retroactive to the date of the birth/adoption).

General Rule: Section 125 Cafeteria Plan Irrevocable Election

Employees’ elections to pay the employee-share of the premium for health and welfare plan coverage on a pre-tax basis or make pre-tax FSA contributions 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 affirmative or default election not to participate) must be:

1. made prior to the start of the plan year, and

2. irrevocable for the plan year unless the employee experiences a Section 125 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). Most cafeteria plans provide a window of 30 days for an employee to make a mid-year election change upon experiencing a permitted election change event.

For more details:

• Newfront Section 125 Cafeteria Plan Guide

• Newfront Section 125 Permitted Election Change Event Chart

When Mid-Year Election Changes Are Effective

Most employee health and welfare plan elections are tied to a pre-tax contribution through the employer’s Section 125 cafeteria plan. Accordingly, the effective date of employees’ mid-year election changes must comport with the cafeteria plan restrictions, which generally require that any election change to be prospective. In other words, the employee cannot make a pre-tax contribution for an election change for any period prior to the date of the election.

In most cases, the effective date of a mid-year election change is a plan design choice. However, as described in more detail below, the Section 125 restrictions are such that most employers will choose to make election changes effective only on a prospective basis unless a retroactive pre-tax payment exception applies.

There are three main options employers have for when a mid-year election change will take effect:

1. First of the Month Following the Election Change Request Date (Most Common/Recommended)

2. The Date of the Election Change Request (Confirm with Carriers/Stop-Loss)

3. The Date of the Event (Must Address Section 125 Issues, Confirm with Carriers/Stop-Loss)

Option #1: Mid-Year Election Effective First of the Month Following Election Change Request

This is the standard, default approach for most employers in administering mid-year election changes. It avoids complications with the Section 125 cafeteria plan, does not require any special approval from the insurance carriers/TPAs/stop-loss providers, is consistent with the applicable HIPAA special enrollment event requirements, and provides a sufficient buffer for administrative purposes.

Example #1

• Lindsay, an employee of the Bluth Company, marries Tobias on April 19.

• This is a Section 125 permitted election change event, as well as a HIPAA special enrollment event.

• Lindsay submits an election change request on April 22 to enroll Tobias in the Bluth Company group health plan.

Result #1

• Tobais’s enrollment in the plan is effective as of May 1.

• May 1 is the first of the month following Lindsay’s April 22 election change request date.

Example #2

• Same facts as Example #1, but Lindsay does not submit the election change request until May 14.

Result #2

• Tobias’s enrollment in the plan is effective as of June 1.

• June 1 is the first of the month following Lindsay’s May 14 election change request date.

These examples highlight the significance of the date the employee makes the election change request. Although in both examples the date of the event (marriage) was mid-April, the date the employee requests the election change will determine whether the spouse has coverage starting in May or June. In both examples, the employee has made a valid election change request within 30 days of the event, but the timing of that request can cause an additional month’s delay in coverage for the new spouse.

Option #2: Mid-Year Election Effective Date of the Election Change Request

This approach does not create any Section 125 cafeteria plan issues because there is no coverage retroactive from the date of the election change request. However, it is more generous than is required by the HIPAA special enrollment rules, which generally requires that an election be effective no later than the first of the month following the date of the election change request. Accordingly, employers would need to confirm approval of this approach with the applicable insurance carriers/TPAs/stop-loss providers.

Example #3

• Maeby, an employee of Tantamount Studios, is covered through her parent’s health plan at the Bluth Company.

• She turns age 26 on September 22 and loses coverage under the Bluth plan as of that date.

• This is a Section 125 permitted election change event, as well as a HIPAA special enrollment event.

• Maeby submits an election change request on September 23 to enroll in the Tantamount Studious group health plan.

Result #3

• Maeby’s enrollment in the plan is effective as of September 23, the election change request date.

Example #4

• Same facts as Example #3, but Maeby does not submit the election change request until October 18.

Result #4

• Maeby’s enrollment in the plan is effective as of October 18, the election change request date.

These examples again highlight the significance of the date the employee makes the election change request. Although in both examples the date of the event (loss of coverage) was mid-September, the date the employee requests the election change will determine which day in September or October the employee will be enrolled.

Option #3: Mid-Year Election Effective Date of the Event

This approach creates the most issues from a compliance perspective because it involves retroactive coverage. The Section 125 rules provide that—absent an exception—employees cannot pay for any period of retroactive coverage on a pre-tax basis through the cafeteria plan. Making coverage effective the date of the event is difficult to reconcile with this basic cafeteria plan requirement that any election change be prospective.

Given that employees cannot make a pre-tax contribution for an election change for any period prior to the date of the election change request, employers talking this approach have two options for addressing the period of retroactive coverage (i.e., from the date of the event through the date of the election change request):

1. The employer may pay for the full cost of coverage in the retroactive period; or

2. The employer may require that the employee pay the cost of coverage for the retroactive period on an after-tax basis outside of the cafeteria plan.

Needless to say, neither of those options are ideal. Furthermore, because this approach is more generous than is required by the HIPAA special enrollment rules, employers would need to confirm approval of this “date of event” approach with the applicable insurance carriers/TPAs/stop-loss providers.

Example #5

• George Michael, an employee of the Banana Stand, marries Ann on July 15.

• This is a Section 125 permitted election change event, as well as a HIPAA special enrollment event.

• George Michael submits an election change request on August 1 to enroll Ann in the Banana Stand group health plan.

• The employee-share of the premium for the spousal coverage is $250 each semi-monthly payroll.

Result #5

• Ann’s enrollment in the plan is effective as of July 15, the date of the event (marriage).

• George Michael cannot pay the $250 employee-share of the premium for the retroactive period of Ann’s coverage from July 15 – July 31 on a pre-tax basis through the cafeteria plan.

• The Banana Stand can either pay the $250 on George Michael’s behalf for that retroactive period of Ann’s coverage, or they can require that George Michael pay the $250 for the retroactive period of Ann’s coverage on an after-tax basis.

• George Michael can begin paying for Ann’s coverage on a pre-tax basis with the period beginning on August 1, the date of the election change request (i.e., George Michael can pay the $250 employee-share of the premium for Ann’s coverage in the August 15 payroll on a pre-tax basis through the cafeteria plan for the period from August 1 – August 15).

While this approach does have the advantage of avoiding potential gaps in coverage related to the event based on when the employee makes the election change request, it creates multiple administrative headaches for employers. Accordingly, most employers are better served by avoiding this option and instead providing prospective coverage upon a mid-year election change pursuant to the first two options described above.

Exception: Retroactive Pre-Tax Payment for New Children

HIPAA special enrollment events are a subset of the Section 125 permitted election change events that provide employees with additional mid-year enrollment rights.

The following events qualify as HIPAA special enrollment events:

• Loss of eligibility for group health coverage or individual health insurance coverage;

• Loss of Medicaid/CHIP eligibility or becoming eligible for a state premium assistance subsidy under Medicaid/CHIP; and

• Acquisition of a new spouse or dependent by marriage, birth, adoption, or placement for adoption.

For more details: HIPAA Special Enrollment Events

The general rule is that an election to enroll an employee and/or dependent in coverage pursuant to a HIPAA special enrollment event must be effective no later than the first of the month following the date of the election change request. However, with respect to the birth, adoption, and placement for adoption events only, coverage for the new child must be effective as of the date of the event (i.e., the date of the birth, adoption, or placement for adoption).

The Section 125 rules accommodate this retroactive coverage HIPAA special enrollment right for newborn/newly adopted children by permitting employees to pay the employee-share of the premium for the retroactive period of coverage on a pre-tax basis through the cafeteria plan. This is an exception to the general rule described above, which otherwise requires prospective employee pre-tax payment elections.

Example #6

• Lucille, an employee of the Bluth Company, adopts a child Annyong on November 23.

• This is a Section 125 permitted election change event, as well as a HIPAA special enrollment event.

• Lucille submits an election change request on December 17 to enroll Annyong in the Bluth Company group health plan.

Result #6

• Annyong’s enrollment in the plan is effective as of November 23, the date of the event (adoption).

• Lucille can pay the employee-share of the premium for Annyong’s coverage on a pre-tax basis through the cafeteria plan retroactive to the November 23 date of enrollment.

Exception: Retroactive Pre-Tax Payment for New Hires

In many cases, employers will design their health plan to provide coverage that is effective as of the date of hire. This will result in a period of retroactive coverage from the new hire’s start date to the election date.

The Section 125 rules accommodate this common plan design by permitting employees to pay the employee-share of the premium for the retroactive period of coverage on a pre-tax basis through the cafeteria plan. This is an exception to the general rule described above, which otherwise requires prospective employee pre-tax payment elections.

In order to take advantage of this retroactive payment option to the date of hire, the Section 125 rules require that the election be made within 30 days of the employee’s hire date. Accordingly, this retroactive payment option is available only where a) coverage is effective date of hire, and b) the employer restricts the enrollment window to 30 days after the employee’s hire date.

• For more details: The 30-Day New Hire Election Period

Furthermore, the Section 125 rules provide that an employer utilizing this new hire retroactive pre-tax payment provision must reinstate employees to their previous elections for the plan year if they are rehired or return from unpaid leave within 30 days of the termination or initiation of the leave. In other words, employees do not have the option to change their election upon rehiring or returning from unpaid leave within 30 days.

• For more details: Health Plan Elections Upon Rehire or Return from Leave

Example #7

• George Oliver “Gob” Bluth II’s date of hire with The Alliance of Magicians is June 12.

• The Alliance of Magicians group health plan provides coverage with a date of hire effective date for employees who enroll within the 30-day new hire window.

• Gob submits his new hire election on July 4 to enroll in the health plan.

Result #7

• Gob’s enrollment in the plan is effective as of June 12, the date of hire.

• Gob can pay the employee-share of the premium on a pre-tax basis through the cafeteria plan retroactive to the June 12 date of hire.

Mid-Year Election Change Enforcement

The Section 125 rules provide that the IRS could cause the entire cafeteria plan to lose its tax-advantaged status (i.e., lose the safe harbor from constructive receipt) if failures to properly follow the election change rules outlined above were discovered on audit. That could result in all elections becoming taxable for all employees.

For more details:

• The Section 125 Safe Harbor from Constructive Receipt

• Newfront Section 125 Cafeteria Plan Guide

• Newfront Section 125 Permitted Election Change Event Chart

What About Gaps in Coverage?

In the standard scenario where an employee’s or dependent’s enrollment upon experiencing a permitted election change event is not effective until the first of the month following the election change request, employees will often complain that there will be a gap in coverage from the date of the event/request to the enrollment date. This is of course true. As highlighted in the examples above, this can be mitigated to some extent by employees submitting their election change request quickly. However, there will still be a gap.

Fortunately, COBRA is designed to address that very issue. COBRA provides qualified beneficiaries with the right to continuous, seamless coverage upon experiencing a qualifying event. A loss of coverage caused by an employee’s or dependent’s termination of employment, reduction of hours, death, divorce, legal separation, or loss of dependent status is a qualifying event that will provide COBRA continuation rights.

• For more details: Newfront COBRA for Employers Guide

In situations where employees will have a short gap in coverage (e.g., a month or two), employees will often be even better served by the gap than if coverage had been immediately effective as of the date of the event. Employees can delay any non-urgent appointments or expenses for that short period and avoid paying any premium for coverage. Plus, if anything urgent arises during that period, employees have the full 60-day COBRA election window available to elect COBRA retroactively to the date active coverage terminated.

Put another way, employees will have the best of both worlds. They can avoid the premium for that short period if no significant need/expenses arise, while maintaining the ability to elect coverage for that full short period at any period within that 60-day COBRA election window in case any significant need/expenses do arise. Plus, state individual mandates generally recognize a “short coverage gap” exemption from any potential penalties for a gap of three consecutive months or less, mirroring the prior ACA exemption.

Summary

Other than situations involving newborns, newly adopted children, and new hires, employers generally follow a practice of making mid-year election change enrollments effective on a prospective basis only, such as the first of the month following the date of the employee’s timely election change request. Any deviation from that approach would require the employer to address the retroactive period of coverage in a manner that does not violate the Section 125 cafeteria plan rules or the insurance carrier and/or stop-loss provider limitations.

Relevant Cites:

Prop. Treas. Reg. §1.125-1

(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—

…

(F) Allowing employees to revoke elections or make new elections, except as provided in §1.125-4 and paragraph (a) in §1.125-2;

Prop. Treas. Reg. §1.125-2

(4) Exceptions to rule on making and revoking elections. If a cafeteria plan incorporates the change in status rules in §1.125-4, to the extent provided in those rules, an employee who experiences a change in status (as defined in §1.125-4) is permitted to revoke an existing election and to make a new election with respect to the remaining portion of the period of coverage, but only with respect to cash or other taxable benefits that are not yet currently available.

…

(d) Optional election for new employees. A cafeteria plan may provide new employees 30 days after their hire date to make elections between cash and qualified benefits. The election is effective as of the employee's hire date. However, salary reduction amounts used to pay for such an election must be from compensation not yet currently available on the date of the election. The written cafeteria plan must provide that any employee who terminates employment and is rehired within 30 days after terminating employment (or who returns to employment following an unpaid leave of absence of less than 30 days) is not a new employee eligible for the election in this paragraph (d).

Treas. Reg. §1.125-4

(b) Special enrollment rights.

(1) In general. A cafeteria plan may permit an employee to revoke an election for coverage under a group health plan during a period of coverage and make a new election that corresponds with the special enrollment rights provided in section 9801(f).

…

M's cafeteria plan may permit A to change A's salary reduction election to family coverage for salary not yet currently available. The increased salary reduction is permitted to reflect the cost of family coverage from the date of adoption.

…

M's cafeteria plan may permit E to change E's salary reduction election to reflect the change to family coverage under M's accident or health plan because the marriage would result in special enrollment rights under section 9801(f), pursuant to which an election of family coverage under M's accident or health plan would be required to be effective no later than the first day of the first calendar month beginning after the completed request for enrollment is received by the plan. Since no retroactive coverage is required in the event of marriage under section 9801(f), E's salary reduction election may only be changed on a prospective basis.

…

(c) Changes in status.

(1) Change in status rule. A cafeteria plan may permit an employee to revoke an election during a period of coverage with respect to a qualified benefits plan (defined in paragraph (i)(8) of this section) to which this paragraph (c) applies and make a new election for the remaining portion of the period (referred to in this section as an election change)….

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).