Question: What are the consequences of an employer making a mid-year contribution change to the employee share of the premium?
Compliance Team Response:
The good news is that the employer can change its contribution rate at any point. The bad news is it may trigger a mini-OE for the affected employees. There are specific permitted election change event rules in Section 125 designed to address this situation.
The two relevant events at issue here will be the cost change events. There are two versions of this event:
1. Insignificant Cost Changes: Where the change in cost to the employee is not “significant,” the employer can automatically change employees’ elections to match the new cost of coverage. In this case, no mini-OE would be required—the employer would simply map elections to the new cost of coverage.
The problem here is that the IRS has never defined what constitutes a “significant” cost change. The only example in the regulations finds a cost change of 12.5% to be significant. However, IRS officials have stated not to use this number as a safe harbor or a generally applicable dividing line between significant and insignificant.
The only informal guidance the IRS has provided is that employers should look at all the facts and circumstances to determine whether the cost change is insignificant. In general, the cautious approach is to assume that most non-nominal changes in the cost of coverage will be considered significant.
2. Significant Cost Changes: Where the change in the cost of coverage is “significant” (again, a facts and circumstances analysis), employees will have the ability to change their election to a different plan option. This would be the equivalent of a sort of mid-year mini OE for employees.
(Note that neither of these cost change events permit a mid-year election change to the health FSA.)
Although is unlikely that a carrier would refuse to accept mid-year election changes resulting from a significant cost change, it would be best to confirm this with the carriers before proceeding.
Treas. Reg. §1.125-4(f):
(f) Significant cost or coverage changes.
1) In general. Paragraphs (f)(2) through (5) of this section set forth rules for election changes as a result of changes in cost or coverage. This paragraph (f) does not apply to an election change with respect to a health FSA (or on account of a change in cost or coverage under a health FSA).
The main difference is that the employee generally cannot drop coverage altogether in response to a significant cost change unless no similar alternative coverage is available.
(2) Cost changes.
(i) Automatic changes. If the cost of a qualified benefits plan increases (or decreases) during a period of coverage and, under the terms of the plan, employees are required to make a corresponding change in their payments, the cafeteria plan may, on a reasonable and consistent basis, automatically make a prospective increase (or decrease) in affected employees’ elective contributions for the plan.
(ii) Significant cost changes. If the cost charged to an employee for a benefit package option (as defined in paragraph (i)(2) of this section) significantly increases or significantly decreases during a period of coverage, the cafeteria plan may permit the employee to make a corresponding change in election under the cafeteria plan. Changes that may be made include commencing participation in the cafeteria plan for the option with a decrease in cost, or, in the case of an increase in cost, revoking an election for that coverage and, in lieu thereof, either receiving on a prospective basis coverage under another benefit package option providing similar coverage or dropping coverage if no other benefit package option providing similar coverage is available. For example, if the cost of an indemnity option under an accident or health plan significantly increases during a period of coverage, employees who are covered by the indemnity option may make a corresponding prospective increase in their payments or may instead elect to revoke their election for the indemnity option and, in lieu thereof, elect coverage under another benefit package option including an HMO option (or drop coverage under the accident or health plan if no other benefit package option is offered).
(iii) Application of cost changes. For purposes of paragraphs (f)(2)(i) and (ii) of this section, a cost increase or decrease refers to an increase or decrease in the amount of the elective contributions under the cafeteria plan, whether that increase or decrease results from an action taken by the employee (such as switching between full-time and part-time status) or from an action taken by an employer (such as reducing the amount of employer contributions for a class of employees).
(iv) Application to dependent care. This paragraph (f)(2) applies in the case of a dependent care assistance plan only if the cost change is imposed by a dependent care provider who is not a relative of the employee. For this purpose, a relative is an individual who is related as described in section 152(a)(1) through (8), incorporating the rules of section 152(b)(1) and (2).
(i) Employee G is married to Employee H and they have one child, J. Employee G’s employer, O, maintains a calendar year cafeteria plan that allows employees to elect coverage under a dependent care FSA. Child J is cared for by Z, G’s household employee, who is not a relative of G and who provides child care services at an annual cost of $4,000. Prior to the beginning of the year, G elects salary reduction contributions of $4,000 during the year to fund coverage under the dependent care FSA for up to $4,000 of reimbursements for the year. During the year, G raises Z’s salary. Employee G now wants to revoke G’s election under the dependent care FSA, and make a new election under the dependent care FSA to an annual amount of $4,500 to reflect the raise.
(ii) The raise in Z’s salary is a significant increase in cost under paragraph (f)(2)(ii) of this section, and an increase in election to reflect the raise corresponds with that change in status. Thus, O’s cafeteria plan may permit G to elect to increase G’s election under the dependent care FSA.
About the author
Lead Benefits Counsel
Brian Gilmore is the Lead Benefits Counsel at Newfront. He assists clients on a wide variety of employee benefits compliance issues. The primary areas of his practice include ERISA, ACA, COBRA, HIPAA, Section 125 Cafeteria Plans, and 401(k) plans. Brian also presents regularly at trade events and in webinars on current hot topics in employee benefits law. Connect with Brian on LinkedIn.
The information provided is of a general nature and an educational resource. It is not intended to provide advice or address the situation of any particular individual or entity. Any recipient shall be responsible for the use to which it puts this document. Newfront shall have no liability for the information provided. While care has been taken to produce this document, Newfront does not warrant, represent or guarantee the completeness, accuracy, adequacy, or fitness with respect to the information contained in this document. The information provided does not reflect new circumstances, or additional regulatory and legal changes. The issues addressed may have legal, financial, and health implications, and we recommend you speak to your legal, financial, and health advisors before acting on any of the information provided.
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