Can retroactive benefit elections be paid on a pre-tax basis?

Question

Can our company’s healthcare plans, which are partially funded through pre-tax employee contributions under an Internal Revenue Code section 125 cafeteria plan, allow midyear election changes to be effective retroactively for all section 125 qualified status changes and HIPAA special enrollment events?

Answer

In general, section 125 does not allow retroactive coverage paid with pre-tax employee contributions, with two exceptions: 1) when new hires have no waiting period for benefits; and 2) for employees requesting enrollment under the HIPAA special enrollment rules due to the birth, adoption or placement for adoption of a child.

Section 125 rules

Section 125 provides a vehicle for employees to pay for certain benefits on a pre-tax basis. It also requires that employers only permit employees’ benefit elections to be paid with employee pre-tax contributions on a prospective basis, generally affecting pay the employee has not yet earned. This means that plans allowing employees to pay for coverage using pre-tax salary reductions under a section 125 plan may only let employees make pre-tax elections that are effective after the election request is submitted, with two exceptions. Employees may make pre-tax retroactive elections:

• For the birth, adoption or placement for adoption of a child, because of the HIPAA special enrollment rules (see below)
• When new employees have no waiting period for their benefits

A plan that imposes no waiting period and allows coverage to begin on the date of hire may allow new employees to make a retroactive election paid with pre-tax employee contributions within 30 days of the date of hire. However, if the plan has a waiting period (e.g., the first of the month following the date of hire or 30 days), the new employee can only make a prospective election.

HIPAA special enrollment rules

Under the HIPAA special enrollment rules, an employee gaining a new dependent due to 1) the birth, adoption or placement for adoption of a child; or 2) marriage may request enrollment in group health plan coverage during the special enrollment period (of at least 30 days — or longer if the section 125 plan documents and group health plan allow it). For birth, adoption or placement for adoption, a retroactive election to add the child (and the employee or spouse if not previously enrolled) to healthcare coverage is allowed, meaning that the employee can pay for that coverage on a pre-tax basis. However, a retroactive pre-tax election change is not allowed in the event of a marriage or other HIPAA special enrollment event. Typically, a new spouse’s coverage effective date could only be the date of the request to add coverage or the first of the month following the event (depending on the plan provisions).

Retroactive post-tax coverage

Although the section 125 rules generally prohibit pre-tax retroactive coverage changes, a retroactive coverage change paid with after-tax employee contributions appears to be allowable. If the employee or spouse is permitted to enroll retroactively back to the date of marriage, the cost of the retroactive coverage must be paid with after-tax dollars.

For example, Employee A elects employee-only coverage beginning January 1 for a calendar-year plan. Employee A gets married on May 1 and notifies the plan of the marriage on May 29 (which is within 30 days as required by the plan provisions). Under section 125, Employee A may make an election change to enroll the spouse, but pre-tax employee contributions for that coverage cannot be effective until on or after the date of the election change request (in accordance with plan terms). However, coverage could be retroactive to May 1 if the employee contributions for the coverage were made on an after-tax basis for the period from May 1 through May 29. Employee contributions could be made on a pre-tax basis after May 29.

Takeaways

• Employers should discuss with their plan administrators to determine whether the plan complies with the section 125 and HIPAA special enrollment rules discussed above.
• Employers should review their plan documents and summary plan descriptions and make changes, if necessary, to ensure they accurately describe the coverage effective date and pre-tax/after-tax nature of employee contributions in an election change scenario.