When a Cafeteria Plan Election Can Change Mid-Year

Answer first: the regulation is a ceiling, not a floor

The permitted election change regulation opens with a permission and closes the paragraph with a disclaimer. "A cafeteria plan may permit an employee to revoke an election during a period of coverage and to make a new election only as provided in paragraphs (b) through (g) of this section." Then: "Section 125 does not require a cafeteria plan to permit any of these changes."

That construction defines the whole subject. The regulation lists the outer limit of what an employer's plan is allowed to offer. Whether a particular plan offers any of it is a question about the plan document, not about federal law.

The underlying statute explains why the constraint exists at all. Section 125's general rule is that no amount is included in a participant's gross income "solely because, under the plan, the participant may choose among the benefits of the plan." A cafeteria plan is defined as a written plan under which all participants are employees and the participants may choose among two or more benefits consisting of cash and qualified benefits. The election-change rules exist to keep that choice from becoming a running ability to convert taxable cash into untaxed benefits as expenses arise.

The regulation groups the permitted changes into six categories: special enrollment rights, changes in status, a judgment, decree or order, entitlement to Medicare or Medicaid, significant cost or coverage changes, and a special provision for leave under the Family and Medical Leave Act.

Changes in status, and the consistency rule that governs them

A plan may permit an election change on a change in status only if two conditions are both met: a listed change in status occurs, and the election change satisfies the consistency rule.

The listed events are specific. Changes in legal marital status, including marriage, death of a spouse, divorce, legal separation and annulment. Changes in the number of dependents, including birth, death, adoption and placement for adoption. Changes in employment status of the employee, spouse or dependent — termination or commencement of employment, a strike or lockout, commencement of or return from an unpaid leave of absence, and a change in worksite — plus any change in employment status that causes the individual to become or cease to be eligible under a plan whose eligibility depends on that status. Events that cause a dependent to satisfy or cease to satisfy eligibility requirements on account of age, student status or a similar circumstance. A change in the place of residence of the employee, spouse or dependent. And, for adoption assistance, the commencement or termination of an adoption proceeding.

The consistency rule is where most of the analysis happens. For accident or health coverage and group-term life insurance, an election change qualifies "only if the election change is on account of and corresponds with a change in status that affects eligibility for coverage under an employer's plan," and the regulation states that a change affecting eligibility includes one that increases or decreases the number of family members or dependents who may benefit from coverage.

The rule then blocks the obvious abuse. If the change in status is a divorce, annulment or legal separation, the death of a spouse or dependent, or a dependent ceasing to satisfy eligibility requirements, an election to cancel coverage "for any individual other than" the person actually affected "fails to correspond with that change in status." A dependent's death does not open the door to dropping the employee's own coverage.

There is a mirror rule for coverage picked up elsewhere. Where an employee, spouse or dependent gains eligibility under a family member's plan because of a marital status or employment status change, an election to cease or decrease that individual's coverage under the cafeteria plan corresponds with the change "only if coverage for that individual becomes applicable or is increased under the family member plan." And the regulation includes an explicit exception permitting a plan to let an employee increase payments to pay for continuation coverage where the employee, spouse or dependent becomes eligible for coverage under section 4980B or a similar state law.

Special enrollment, court orders, and Medicare or Medicaid

The special enrollment provision is the shortest of the six. A plan may permit an employee to revoke a group health plan election during a period of coverage and make a new election "that corresponds with the special enrollment rights provided in section 9801(f)." The regulation's worked examples show the practical consequence: where the underlying special enrollment right requires coverage to be effective retroactively — an adoption is the example given — the salary reduction change may reflect the cost from that date, while for a marriage, where no retroactive coverage is required, the salary reduction election "may only be changed on a prospective basis."

The judgment, decree or order provision covers an order resulting from a divorce, legal separation, annulment or change in legal custody, including a qualified medical child support order, that requires accident or health coverage for a child or for a foster child who is a dependent. A plan may change the employee's election to provide coverage if the order requires coverage under the employee's plan, or permit the employee to cancel coverage for the child if the order requires another person to provide it "and that coverage is, in fact, provided." The second condition is doing real work: the order alone is not enough.

The Medicare and Medicaid provision runs in both directions. If an employee, spouse or dependent enrolled in the employer's accident or health plan becomes entitled to — the regulation glosses this as becomes enrolled in — coverage under Medicare Part A or Part B or under Medicaid, other than coverage consisting solely of pediatric vaccine benefits, the plan may permit a prospective election change to cancel or reduce that person's coverage. If someone who had such coverage loses eligibility for it, the plan may permit a prospective election to commence or increase coverage.

Note the word "prospective" in that provision. It appears twice, and it is the limit on what the change can reach.

Cost and coverage changes, and the health FSA exclusion

The fifth category is the broadest, and it comes with a carve-out stated in its own opening sentence: this paragraph "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)." Every rule that follows is unavailable for a health flexible spending arrangement.

On cost, there are two mechanisms. Where the cost of a qualified benefits plan increases or decreases during a period of coverage and the plan's terms require employees to make a corresponding change, the cafeteria plan may automatically make a prospective increase or decrease in affected employees' elective contributions "on a reasonable and consistent basis." Where the cost charged for a benefit package option "significantly increases or significantly decreases," the plan may permit a corresponding election change — including beginning participation for an option whose cost dropped, or, on an increase, revoking the election and either taking another option providing similar coverage or dropping coverage if no similar option is available.

A cost change is defined by reference to the employee's contributions, and the regulation states it can result from an action by either side — the employee switching between full-time and part-time status, or the employer reducing its contributions for a class of employees.

On coverage, the regulation distinguishes curtailment from loss. A significant curtailment that is not a loss of coverage — the examples given are a significant increase in the deductible, the copay or the out-of-pocket cost sharing limit — allows a participant to revoke and elect another option providing similar coverage, but not to drop coverage. Coverage is significantly curtailed "only if there is an overall reduction in coverage provided under the plan so as to constitute reduced coverage generally," and the regulation adds that "in most cases, the loss of one particular physician in a network does not constitute a significant curtailment."

A significant curtailment that is a loss of coverage does allow dropping coverage where no similar option is available. Loss of coverage means a complete loss under the option — the regulation names elimination of a benefit package option, an HMO ceasing to be available where the individual resides, and losing all coverage under the option through an overall lifetime or annual limitation. A plan may, in its discretion, also treat as a loss of coverage a substantial decrease in the medical care providers available under the option, a reduction in benefits for a specific condition or treatment with respect to which the person is currently in a course of treatment, or any other similar fundamental loss of coverage.

Adding or significantly improving an option also opens a window, as does a corresponding change made under another employer's plan, and so does losing coverage under group health coverage sponsored by a governmental or educational institution — the regulation lists a state children's health insurance program, an Indian Tribal government, Indian Health Service or tribal organization medical care program, a state health benefits risk pool, and a foreign government group health plan.

Why the health FSA is treated differently

Reading the regulation's worked examples side by side makes the design visible. In one, mid-year negotiations reduce indemnity premiums, cut office visit copayments by an amount constituting a significant benefit improvement, and add an HMO option. The plan may automatically decrease salary reduction contributions to match the premium change, and may permit employees to elect the indemnity plan or the new HMO. But "the plan may not permit employees to change their health FSA elections to reflect the mid-year change in copayments," and it may not permit a change to reflect copayment differences under the new HMO option either.

Another example runs the same way. A spouse's employer adds family coverage mid-year, the spouse elects it, and the employee wants to drop coverage under their own employer's cafeteria plan. The regulation permits the revocation if the spouse actually elects the family coverage — and then states flatly that the plan "may not permit C to change C's health FSA election."

A dependent care flexible spending arrangement is treated differently from a health one. Where a new child care provider becomes available, the regulation treats that as a significant change in coverage similar to a benefit package option becoming available, and permits a revocation and corresponding new election — "because the FSA is a dependent care FSA rather than a health FSA."

The definitional section reinforces the separation. "Similar coverage" means coverage for the same category of benefits for the same individuals, and "for purposes of this definition, a health FSA is not similar coverage with respect to an accident or health plan that is not a health FSA." A health FSA and a medical plan are never each other's substitute under these rules.

The statute adds a separate constraint on health FSAs that has nothing to do with election changes. A benefit provided through employer contributions to a health flexible spending arrangement is not a qualified benefit unless the plan provides that an employee may not elect salary reduction contributions in excess of a stated amount for a taxable year — a $2,500 base figure indexed for taxable years beginning after 2013 from calendar year 2012, with any increase rounded to the next lowest multiple of $50. That is a plan design requirement, not an election change rule, and no current-year figure is stated here.