QUESTION: Our company currently pays 90% of the premiums for coverage under our employer-sponsored dental plan, but, for financial reasons, we need to reduce this amount midyear to 50%. To minimize the financial impact on our employees, can we let them change their cafeteria plan elections to pay for the additional cost on a pre-tax basis?
ANSWER: Yes, if your cafeteria plan is drafted to incorporate the full range of options allowed under the IRS permitted election change regulations with respect to cost changes. Under the significant cost-change provision of the regulations, if “the cost charged to an employee for a benefit package option . . . significantly increases or significantly decreases during a period of coverage [in this case, the plan year], the cafeteria plan may permit the employee to make a corresponding change in election.”
The regulations provide little guidance regarding what constitutes a significant cost change, leaving employers to determine whether a cost change is significant. However, in an example relating to DCAP benefits, a midyear change in the cost of care of 12.5% (from $4,000 to $4,500) is a significant increase allowing an election change. Thus, factors to consider include the dollar amount or percentage of the increase. It is unclear what role (if any) affordability to participants may play. (A $10-per-month increase for minimum-wage employees is more significant than a similar increase for highly paid professionals.) Employers may also consider how the increase compares with past increases under the plan. If a cost increase is not significant, and the plan document requires corresponding changes in employees’ payments, then employees’ contributions can be increased automatically under the automatic cost-change provision of the regulations. Note that neither of the cost change provisions applies to health FSAs.
If the cost increase is significant, the regulations allow cafeteria plans to offer employees three options. Employees may—
Continue their existing health coverage and pay the increased contributions on a pre-tax basis;
Revoke their elections for the existing health coverage and choose instead to receive, on a prospective basis, coverage under another benefit package option that provides “similar coverage;” or
Drop their existing coverage, but only if no other benefit package option providing similar coverage is available. The regulations define similar coverage as “coverage for the same category of benefits for the same individuals (e.g., family to family or single to single)” and explain, among other things, that two plans that provide major medical coverage are considered similar coverage.
To understand which election change options are available to your employees, check your cafeteria plan document to see if it incorporates the full range of options allowed under IRS regulations and if it includes special provisions regarding similar coverage. (For example, the regulations allow a cafeteria plan to treat coverage under another employer’s plan, such as the plan of a spouse’s or dependent’s employer, as similar coverage.) Note that nothing in the regulations seems to prohibit a plan sponsor from amending its cafeteria plan as needed to add such language, so long as the amendment and any election changes are applied prospectively. You should also check the dental plan for any restrictions on midyear election changes.
For more information, see EBIA’s Cafeteria Plans manual at Sections XIV.D (“Cost Changes With Automatic Increases/Decreases in Elective Contributions”) and XIV.E (“Significant Cost Changes”).
Contributing Editors: EBIA Staff.