Q: We have an employee who wants to make changes to her cafeteria plan election, even though benefits are already effective. Is there a grace period that allows her to change her election?

Employers: Don’t make this common cafeteria plan mistake!

Once cafeteria plan benefits become effective, the elections are “locked in.” Employees cannot change their minds and make changes to pre-tax cafeteria elections during the plan year, once benefits become effective — unless a special enrollment period as defined under IRC Section 125 applies, or the employer is correcting an administrative error.

Many group health insurance plan sponsors and administrators have the mistaken belief that the law allows employees enrolling in Section 125 cafeteria plans to change their elections, as long as they do so within 30 days of the plan becoming effective.

This is not correct. And this misconception can have serious consequences. It can even jeopardize the tax-favored status of the entire plan.

The facts

While most insurance carriers and cafeteria plan benefit vendors allow for changes to employee pre-tax elections in cafeteria plans within 30 days, the IRS does not.

Once coverage becomes effective, the elections are irrevocable. Employees cannot change their minds during the plan year outside of a special enrollment period authorized under Section 125. Examples include a change in marital status, change in employment, reduction of work hours, enrollment in a qualified health plan, among others.

The IRS has issued informal guidance that employers can correct an administrative error without jeopardizing the plan’s tax-favored status. But there must be “clear and convincing evidence” that the change in election is being made to correct an administrative error.

An employee changing his or her mind does not count.

The consequences

If an employer makes a change to an employee’s cafeteria plan election, there’s no applicable special enrollment provision such as a change in marital status, and there’s no clear and convincing evidence of an administrative error, the IRS may disallow the entire plan.

That means the tax benefits of your Section 125 cafeteria plan will disappear, resulting in income tax liability for the worker.

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