(From the September 16, 2002 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits. Hyperlinks within the article have been added by BenefitsLink.)
Circumstances in Which Section 125 Cafeteria Plans May Permit Mid-Year Election Changes with Respect to Selected Benefits
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Treasury regulations/1/ authorize IRC §125 cafeteria plans to allow participants to make mid-year election changes in the case of certain change in status events, but only if the "consistency rule" is satisfied. In general, the consistency rule is made up of the following two elements:
If either (or both) of these elements is not present, the consistency rule is not satisfied and the cafeteria plan may not allow the participant to make the proposed mid-year election change. Each element is discussed in more detail below.
/1/ Treas. Reg. §1.125-4(c).
The Change in Status Affects Eligibility for Coverage Under an Employer's Plan
Many change in status events usually affect eligibility for coverage under an employer's plan. For example, if an employee marries, her new spouse probably becomes eligible for coverage under her employer's group health plan. An employee must be allowed to enroll his new child in his employer's group health plan. If an employee's spouse loses her job, she also loses coverage under her former employer's group health plan.
In addition, certain change in status events by definition affect eligibility for coverage. For example, the fact that an employee's dependent attains a particular age (say, 21) is not a change in status unless, by reason of attaining that age, he no longer is eligible for coverage under the employer's plan. Similarly, an employee's decision to switch from full- to part-time employment status is a change in status only if it causes the employee to no longer be eligible to participate in the employer's group health plan.
However, there are at least two change in status events that may, but often will not, affect eligibility for coverage under an employer's plan: these are a change in residence and a change in worksite. For example, if a cafeteria plan participant elects coverage under an HMO that covers a specific service area, and the participant is subsequently transferred to a worksite in another city, a mid-year election change will not be allowed if the transfer (which is a change in status event) does not affect the participant's eligibility to participate in that HMO. However, if the transfer results in the participant moving to another city that is not within that HMO's service area, the participant may be allowed to revoke the initial election and elect, in its place, another available health care option.
The Mid-Year Election Change Is "on account of and corresponds with" the Change in Status Event
This is the heart of the consistency rule. Simply stated, it means a §125 cafeteria plan may not permit a participant who experiences a change in status event to make a mid-year election change unless the change in status event is the reason for the proposed change, and the proposed change is consistent with that event.
For example, if the participant's change in status event is a dependent ceasing to be eligible for health plan coverage, the participant may be permitted to change her election to discontinue coverage for that dependent. However, the participant could not use this event to justify dropping coverage for her spouse or some other dependent, because there is no connection between the change in status event and these types of changes.
Likewise, if a participant's change in status event is a divorce, she may be permitted to make a midyear election change to discontinue coverage for her former spouse. However, the participant could not use this event to justify dropping coverage for herself and her former spouse.
Finally, consider the following example from the Treasury regulations:
Example 9. (i) Employee A has one child, B. Employee A's employer, X, maintains a calendar year cafeteria plan that allows employees to elect coverage under a dependent care FSA. Prior to the beginning of the calendar year, A 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, B reaches the age of 13, and A wants to cancel coverage under the dependent care FSA.
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