To increase flexibility over aspects of Section 125 cafeteria plans, the IRS recently issued Notice 2020-29
(Notice) that gives employers the choice to allow employees to make new mid-year election changes regarding their health care coverage, health care FSA and/or dependent care FSA. Employers may also expand the claims period for using health care FSA and/or dependent care FSA funds after the end of a grace period or plan year. These changes—which employers may, but are not required to, adopt—are temporary during 2020 and reflect the unanticipated changes brought by the COVID-19 pandemic.
Below is a brief summary of the changes allowed by the Notice and a list of key action steps required to implement any of these options.
New Elections Under Section 125 Cafeteria Plans
As a general rule, employee elections under a Section 125 cafeteria plan cannot be changed mid-year unless the employee experiences a change-in-status event or there are significant changes in the cost of coverage. Without one of these situations applying, the employee is locked into the elections made prior to the start of the plan year.
Under the Notice, employers may now give their employees broad ability during the remainder of 2020 to make the following mid-year changes on a prospective basis:
Extension of Claims Period for Health Care FSA and Dependent Care FSA
- Make a new election for health coverage, if the employee initially declined coverage.
- Revoke an existing election for health coverage and make a new election to enroll in different health coverage sponsored by the employer.
- Revoke an existing election for health coverage, provided that the employee attests in writing to the employer that the employee is enrolled, or immediately will enroll, in other health coverage not sponsored by the employer.
- Revoke an election, make a new election, or decrease or increase an existing election for their health care FSA and/or dependent care FSA.
The Notice also allows employers to adopt the following optional changes regarding their health care FSA and/or dependent care FSA programs:
- Extend the time for employees to apply unused amounts remaining in their health care FSA and/or dependent care FSA at the end of a grace period ending in 2020 (e.g., March 15, 2020) or at the end of a plan year ending in 2020. If an employer adopts this new rule, employees may continue to use those funds to pay for, or be reimbursed for, expenses incurred through December 31, 2020.
- A grace period is a period of up to 2½-months after the end of a plan year in which an employee can incur new expenses paid for using the prior year’s funds. For those plans that have a grace period ending in 2020, the new rule effectively extends the grace period through the end of 2020.
- For non-calendar-year plans without a grace period or carryover, this special extension rule also gives the employee until the end of 2020 to use funds that otherwise would be forfeited at the end of the plan year.
- For a health care FSA with a carryover feature, provide a special extension period for claims beyond the end of the plan year through December 31, 2020.
- A carryover feature allows an employee to transfer up to $500 of unspent funds from the end of a plan year to be used any time in the following year. For a non-calendar-year plan year, this special extension rule effectively gives employees an additional chance to use up funds above the carryover limit before the end of 2020.
- Unfortunately, this special extension period does not help health care FSAs with carryovers that are on a calendar-year plan year.
- For a health care FSA, the carryover amount limit is now indexed to 20% of the health care FSA contribution limit. For health care FSA plan years beginning in 2020, up to $550 may carry over into the 2021 plan year.
As a reminder, participating in a health care FSA during a grace period can disqualify a person from participating in a health savings account (HSA), and the IRS specifically noted that this same rule applies to the special extension period. As a result, employees benefitting from this special extension period may be ineligible to contribute to an HSA during any months of 2020 (unless the health care FSA is designed to be compatible with an HSA, such as certain limited-purpose health care FSAs).
Action Steps to Implement Changes
If your organization would like to make any of these changes, you must:
- Decide which options you wish to adopt, if any.
- Adopt a plan amendment. While the IRS has provided an extended deadline to amend plans until December 31, 2021, best practice is to amend your plan when you decide to make the change—this ensures that the amendment is not overlooked down the road.
- Notify eligible employees. Even if you wait to adopt an amendment, it’s important to promptly notify employees of any changes made, as waiting to notify employees limits the time that employees have to take advantage of these new options.
There are many factors that may affect whether and how you adopt any of these changes. If you would like to discuss implementing these changes, please contact Norbert Kugele
, Stephanie Grant
or any other member of Warner’s Employee Benefits/Executive Compensation Practice Group.