From the Hotline: Change in Cafeteria Plan Election Without Qualifying Event

Question: If an employee elected health benefits coverage in our section 125 cafeteria plan during open enrollment, may he change his mind about coverage in the first month of the new plan year without a qualifying event?

Answer: Cafeteria plans are governed by the employer’s plan document in accordance with Internal Revenue Code § 125. The Code requires plan participants (employees) to make pretax benefit elections prior to the start of the plan year. For reference, here is an excerpt of pertinent regulatory text (Treas. Prop. Reg. 1.125-2(a)(2) as published in the Federal Register 8/6/2007):

(2) Timing of elections. In order for employees to exclude qualified benefits from employees’ gross income, benefit elections in a cafeteria plan must be made before the earlier of:

(i) The date when taxable benefits are currently available, or

(ii) The first day of the plan year (or other coverage period).

Next, pretax benefit elections may not be revoked or changed during the plan year, except in limited cases consistent with and on account of a “permissible election change.” IRS regulations set forth a list of permissible election changes, such as family status changes. The employer’s cafeteria plan document may adopt some or all of the IRS-permissible items, but cannot go beyond the IRS list.

From time to time, employees ask for exceptions to let them change elections in the absence of a permissible election change. The IRS regulations do not provide for exceptions. IRS spokespersons, however, have commented unofficially that employers may make administrative exceptions if there is clear and convincing evidence that an error was made. Generally, this refers only to errors made by the employer (such as data entry errors). The IRS spokespersons have cited only one example of an error made by the employee. The employee mistakenly elected the dependent care account instead of the health care account; in that case, there was clear evidence of the error since the employee had no children and had not elected the dependent care account for prior years.

Lastly, some legal advisors suggest that employers adopt written guidelines for determining whether a mistake was made, and whether the mistake can be corrected, based on the facts and circumstances of each case. The written guidelines should address issues such as documentation (e.g., employee sworn statement regarding the mistake) and the time limit for the employer to advise the employee of the mistake (e.g., fixed number of days after start of plan year or after receipt of first paycheck in the plan year). Keep in mind that the IRS has not commented on nor endorsed these administrative procedures, so employers should consult with their legal advisors before proceeding.