Termination options

[Guest Carolynn]

I have a new client that wants to have termination options different from those we are used to seeing.

Specifically, she wants a terminating ee to have the choice between terminating coverage at date of termination, OR pretaxing the entire remainder of the deductions from the last paycheck, and thus extending coverage until the end of the plan year, for both Medical Reimbursement and Dependent Care reimbursement.

I've suggested she consider Cobra coverage for the Medical Reimbursement account, at least, but she says no, that's not what they have in mind.

Has anyone ever designed a plan like this before?

Thanks!

Carolynn

[papogi]

I have seen this plan design before, and would advise (as you have) against it. Assume an employee terminates with HC and DC accounts. He decides to pre-tax the remainder of the year’s premiums. He is now effectively locked into the coverage up to the end of the year. Assume now that the employee’s child dies. He no longer has need for the DC account. He should have the ability to terminate that coverage, and a prorated portion of the premiums collected up-front would need to be refunded to him [1-125-2 Q7(B)(2) addresses this, but references HC accounts only, although there is no reason to believe the IRS would not apply this rule to a DC account being extended as your client wishes to]. This refunding of monies to a former employee poses logistical problems (e.g., last known address, etc.). Depending on circumstances surrounding the termination of the employee and subsequent hiring by another employer, he may not even be eligible for a DC account anymore (again, monies should then be returned). A former employer has no way to police this, although the compliance to 125 rules by that former employee will still fall under the 125 plan of the employer. They could be setting themselves up for potential compliance problems, even if they are not intended by their former employees. The complications surrounding DC accounts make it obvious why the IRS is silent on them when it comes to extensions of coverage. Since the uniform reimbursement rule does not apply, there is no real reason to offer anything with regards to DC. The former employee leaves, the DC account stops, they go to another employer and can start a new DC account, or just use the tax credit if the new employer has no DC offering. The former employer should not be concerning itself with the DC account at all.

As for the HC account, the former employer has similar problems to the DC account. What if the former employee has a status change, and can drop or reduce the account? The former employer should refund monies to the employee under 1-125-2 Q7(B)(2), otherwise some courts could find that this up-front premium payment eliminates the risk for the employer, and that the 125 plan is out of compliance.

If the employer understands their responsibility to potentially refund monies to former employees, and are comfortable with the logistics involved, then they might be OK with this plan design for HC. That would satisfy any potential COBRA obligations, and they won’t need to worry on that front. I would steer clear of the DC accounts, however, since it is nothing but a waste of time for everyone involved.