Generally, the rules governing Section 125 cafeteria plans require that an employee’s benefit elections be irrevocable throughout each plan year, absent a change in the employee’s status (marriage, divorce, birth of a child, etc.) or significant changes in the cost of coverage during the year. The coronavirus pandemic has given rise to many questions in this area, due to the closing of businesses, schools and day care centers and other factors, and related changes in families’ health care and dependent care needs. On May 12, 2020, the IRS issued two new pieces of guidance (Notices 2020-29 and 2020-33) providing substantial flexibility to change cafeteria plan elections during 2020, as well as extended grace periods for spending unused amounts in both health and dependent care flexible spending accounts (FSAs). A summary of the new guidance is as follows:
With respect to mid-year elections made during calendar year 2020, a cafeteria plan may permit an employee who is eligible to make salary reduction contributions under the plan to:
(1) with respect to employer-sponsored health coverage: (a) make a new election on a prospective basis, if the employee initially declined to elect employer-sponsored health coverage; (b) revoke an existing election and make a new election to enroll in different health coverage sponsored by the same employer on a prospective basis (including a switch from employee-only to family coverage, for example); or (c) revoke an existing election on a prospective basis, provided that the employee attests in writing that the employee is enrolled, or immediately will enroll, in other health coverage not sponsored by the employer;
(2) revoke an election, make a new election, or decrease or increase an existing election regarding a Dependent Care FSA on a prospective basis; and
(3) revoke an election, make a new election, or decrease or increase an existing election applicable to a Health FSA on a prospective basis. (To prevent an employee from failing to cover Health FSA amounts already spent, an employer is permitted to require a decreased Health FSA election to be an amount not less than that already reimbursed in 2020).
Importantly, an employee is not required to demonstrate or represent any particular effect of the coronavirus in order to make the permitted changes; they are available to all plan participants without regard to circumstances.
Unused FSA Amounts:
Generally, cafeteria plans are subject to the “use it or lose it” rule, meaning that unused amounts remaining in FSAs at the end of a plan year are forfeited by the employee. However, a couple of exceptions are available. Under the “carryover rule,” a cafeteria plan may permit unused amounts remaining in a Health FSA as of the end of a plan year to carry over to the following plan year, to pay or reimburse a participant for medical care expenses incurred during such following plan year, subject to the carryover limit (currently $550, as further described below). Under the “grace period rule,” a cafeteria plan may permit a participant to apply unused amounts (including amounts remaining in a Dependent Care FSA as well as a Health FSA) at the end of a plan year to pay expenses incurred for those same benefits during a period of up to two months and 15 days immediately following the end of the plan year (e.g., March 15 for a cafeteria plan operating on the calendar year). A cafeteria plan may include the carryover rule, the grace period rule, or neither rule, but may not include both rules.
Under Notice 2020-29, a cafeteria plan may permit employees to apply unused amounts remaining in a Health FSA or a Dependent Care FSA as of the end of a grace period or plan year ending in 2020 to pay or reimburse medical care expenses or dependent care expenses, respectively, incurred through December 31, 2020. As an example, the grace period for a cafeteria plan for the 2019 calendar year expired March 15, 2020 under the normal rules. The plan may now permit employees to apply any unused amounts to expenses incurred on or before December 31, 2020. (Note: This relief is available to plans with grace periods and plans that do not operate on the calendar year, but is not available to a calendar year plan with no grace period.)
Automatic Adjustment of Health FSA Carryover Amount:
As described above, a cafeteria plan that does not apply the grace period rule is permitted to apply the carryover rule, subject to the carryover limit. Unlike the Health FSA contribution limit ($2,750 in 2020), the carryover limit (previously $500) was not adjusted for inflation. Notice 2020-33 provides for an automatic adjustment to the carryover limit under which it will always be equal to 20% of the Health FSA contribution limit (rounded to the next lowest multiple of $50). Since the 2020 Health FSA contribution limit (as adjusted for inflation) is $2,750, the carryover limit for 2020 will now be adjusted to $550 (20% of $2,750). This change affects the 2020 plan year, for amounts carried over into 2021. (For the 2019 plan year and amounts carried over into 2020, the limit remains $500.) Unlike the changes described above, this change is not a temporary change related to the coronavirus, but will remain in effect for years subsequent to 2020.
Over-the-Counter Medications and Menstrual Products:
Some additional changes affecting cafeteria plans are not the result of the new IRS notices, but were actually included in the Coronavirus Aid, Relief, and Economic Security Act
(the CARES Act) passed by Congress and signed into law by President Trump on March 27, 2020.
By way of background, the Affordable Care Act of 2010 (ACA) provided that, beginning January 1, 2011, a Health FSA was not permitted to reimburse an employee for an over-the-counter (OTC) medication unless the employee had a prescription for the medication. The only available exception was insulin.
The CARES Act provides that OTC medications purchased after December 31, 2019 are reimbursable from Health FSAs, effectively reinstating pre-ACA rules. (Eligible OTC medications include such items as non-prescription pain relievers, antacids, and cold/allergy medicines, but do not include items that are merely beneficial to general health, such as vitamins.) In addition, the CARES Act provides that expenses for menstrual care products (tampons, etc.) are now treated as incurred for medical care, making them reimbursable from Health FSAs.
Unlike the cafeteria plan changes made by Notices 2020-29 and 2020-33, the changes made by the CARES Act are permanent and will not expire at the end of 2020 (or at the end of the pandemic).
Plan Amendments and Employee Communications:
Importantly, all of the changes described above are optional; an employer is permitted, but not required, to make these changes to its particular cafeteria plan. An employer is also permitted to adopt some, but not all, of the available changes. Many employers will want to provide maximum flexibility to their employees. However, increased flexibility for employees could result in increased costs for employers, as lesser forfeitures will be available to offset those costs. Also, the additional flexibility in mid-year changes could result in “adverse selection” with respect to employer-sponsored group health plans, as more employees with greater health care needs will have new opportunities to elect coverage (a factor which has already been exacerbated by the recent DOL guidance giving employees additional time to elect and pay for COBRA coverage). One option is to only permit elections to expand existing coverage (e.g., a change from employee-only coverage to family coverage), but not brand new elections of coverage. In any case, employers should weigh these factors against the value of the advantages to employees. The accompanying 2020 Cafeteria Plan Amendment Checklist can be used by an employer to indicate the changes it wishes to include in its plan amendment.
The new IRS notices permit employers to amend their cafeteria plans as late as December 31, 2021, and to make those amendments retroactive to January 1, 2020. Although no particular grace period was included in the CARES Act (with respect to the changes involving OTC medications and menstrual products), it is also expected that employers have a significant period of time to get those amendments in place. On the other hand, all of these changes are of course helpful to employees only if they are made aware of their availability. While the IRS notices do not impose any particular employee notification deadline, some form of employee
communication, whether in the form of an updated Summary Plan Description, a Summary of Material Modifications, or a simple Notice to Employees, should be provided to employees as soon as possible.
In addition to the lack of a specific employee notification deadline, there are other questions that are not addressed in the IRS notices. For example, does the flexibility surrounding election changes apply to all qualified benefits under Section 125 (including dental and vision coverage), or does it apply only to medical, Health FSA and Dependent Care FSA benefits? Clarification from the IRS on this point would be helpful. Also, will insurance carriers honor this election change flexibility, given the possibility of adverse selection? Employers seeking to adopt changes in this area should check with their carriers before the changes are actually implemented and communicated to employees.