When can an employee change his or her elections under a Section 125 plan?
Under a Section 125 plan, participant elections generally must be irrevocable until the beginning of the next plan year. However, when a participant experiences one of several specific recognized events, he or she may be permitted to make a change in election that is consistent with the event. A change in election must be made prospectively, except in the few cases where HIPAA requires that a change be made effective retroactive to the date of the event.
A Section 125 plan may allow a participant to change his or her elections related to Section 125 plan benefits (other than flexible spending accounts) upon the occurrence of any of the following events:
- Change in status (for example, employee’s legal marital status, number of dependents, employment status, dependent eligibility change or change in residence);
- Significant cost increase;
- Significant curtailment of coverage;
- Addition or elimination of benefit package option;
- Change in coverage under other employer’s plan;
- Loss of group health coverage sponsored by a governmental or educational institution;
- FMLA leaves of absence;
- COBRA qualifying events;
- HIPAA special enrollment events;
- Judgment, decree or court order, such as a Qualified Medical Child Support Order (QMCSO); or
- Medicare or Medicaid entitlement.
When can I change the amount contributed to my Section 125 Dependent Care FSA?
Under a Section 125 plan, participant elections generally must be irrevocable until the beginning of the next plan year. In some cases, a plan may permit a participant to make a mid-year change in election for his or her Dependent Care Flexible Spending Account (Dependent Care FSA). For example, a mid-year election change is permitted when:
- A change in status event occurs, such as a change in the number of dependents;
- An increase in the cost of dependent care occurs, so long as the dependent care provider is not a relative of the employee; or
- A change in status occurs that affects eligibility of dependent care expenses for tax exclusion (for example, an election may be modified where a dependent turns age 13 in the middle of the Section 125 plan year).
Under this rule, it is also likely that some changes in employment status might allow a mid-year election change. For example, an employee taking a leave of absence or moving from full-time to part-time status would be permitted to change their election to correspond with the allowable tax exclusion.
When can I change the amount contributed to my Section 125 Health FSA?
A plan participant is permitted to make a mid-year change to his or her Health Flexible Spending Account (Health FSA) election following a change in status (for example, change in marital status, change in the number of dependents or change in employment status, such as termination or commencement of employment). A plan participant may also change his or her elections at the beginning and end of an FMLA leave.
The IRS rules, however, do not allow plan participants to change their Health FSA election as a result of a change in cost or coverage.
What expenses can be reimbursed under a Section 125 Health FSA?
To be reimbursable under a Health FSA, the expense must be for medical care as defined in Internal Revenue Code section 213. Eligible medical expenses must be incurred:
- During the current Health FSA plan year; and
- By the employee, employee’s spouse or tax dependent.
Beginning March 30, 2010, a Health FSA may be used to reimburse eligible medical expenses for an employee’s child who has not attained age 27 as of the end of the year, regardless of whether the child qualifies as the employee’s tax dependent.
Effective Jan. 1, 2011, employees with a Health FSA can no longer use their account funds to purchase over-the-counter (OTC) drugs, unless they have a prescription for those drugs or the drug is insulin.
Can a Section 125 plan provide a grace period?
Yes. Section 125 plans can provide a grace period of up to 2½ months after the end of a plan year. During this grace period, participants can access unused amounts for reimbursement of expenses related to qualified benefits, such as Health FSA or Dependent Care FSA expenses, for expenses incurred during the grace period. These expenses are treated as though they had been incurred prior to the end of the plan year.
A cafeteria plan is not required to offer a grace period or can choose to offer a shorter grace period than 2½ months. However, if the plan sponsor chooses to provide a grace period, it must make sure that the plan document is amended to provide the grace period. It must also make sure that the grace period applies to all participants who participated in the plan on the last day of the plan year (including COBRA participants).
A grace period should not be confused with a “run-out period.” A run-out period only extends the deadline for submitting expenses for reimbursement. For example, the ABC Co. cafeteria plan contains a 30 day run-out period, but does not include a grace period. The plan year ends on December 31. Due to the run-out period, participants have an extra 30 days after December 31 to submit claims for expenses that were incurred prior to December 31.
What happens if an employee quits and that employee has overspent his or her Section 125 Health FSA?
The employee may not be required to reimburse the Health FSA for any amount owed at the time of termination. It is the IRS’ position that a Health FSA “exhibit the risk-sharing and risk-distribution characteristics of insurance.” In order to reduce the employer’s risk of loss, an employer may impose an annual limit on the amount that can be set aside in a Health FSA or require that an employee serve a waiting period before he or she is eligible to contribute to a Health FSA.
What happens if an employee quits and that employee has underspent his or her Section 125 Health FSA?
When an employee has underspent his or her Health FSA account at the time of the qualifying event, the employee is entitled to elect to continue the Health FSA under COBRA for the remainder of the Section 125 plan year. However, the employee is generally not entitled to continue their contributions to the Health FSA for the maximum COBRA coverage period (for example, 18 months).
Example: Under a Section 125 plan, an employer offers its employees a traditional medical insurance plan and allows its employees to contribute pretax dollars to a Health FSA. Employee elects to contribute $2,000 during the 2012 calendar year. Employee terminates his employment effective July 1, 2012. To date, employee has not sought reimbursement from his Health FSA. Under COBRA, this employee is entitled to continue his Health FSA through the end of December 2012.
Can an employee change his or her elections when taking FMLA leave?
Yes. The commencement of FMLA leave is an event that allows an employee to revoke their existing Section 125 elections, including Health and Dependent Care FSA elections.
The employee’s return from work following FMLA leave is also an event that allows an employee to modify their Section 125 elections, including Health and Dependent Care FSA elections.
How are employee contributions made during FMLA leave?
While on FMLA leave, an employee may be permitted to pay their employee contributions on a pretax basis in one of three ways:
- Pre-pay the amount that would be owed during FMLA leave (provided the FMLA leave does not extend past the end of the Section 125 plan year);
- Pay the amount that is due each month while on FMLA leave (if receiving disability or vacation pay during leave); or
- Catch up on contributions upon return from leave.
If an employer significantly reduces coverage during the middle of the Section 125 plan year, can an employee change his or her elections?
Yes. If the employer significantly reduces coverage, affected plan participants may:
- Revoke their existing election; and/or
- Elect another similar plan, if available.
As with most election changes, the change must be consistent with the event and be made effective going forward.
In the past, health plan coverage must have been provided by an independent third party in order for plan participants to be allowed to make a mid-year change in election following a significant reduction in coverage. Thus, self-funded plans were not able to allow mid-year election changes following a significant change in benefits. Under the proposed IRS rules for Section 125 plans, self-funded plans may now take advantage of the cost or coverage change rules.
Note: The rules do NOT allow a mid-year election change to a Health FSA in response to a significant reduction in coverage.
If an employer adds or eliminates a benefit option during the middle of the Section 125 plan year, can an employee change his or her elections?
Yes. If an employer adds or eliminates a benefit option during the middle of the Section 125 plan year, affected plan participants may make a corresponding change in their election. The change in election must be consistent with the event and be made effective going forward.
Under Section 125, can an employee make a mid-year election change that corresponds with elections a spouse made during their employer’s open enrollment period?
Yes. An employee may make a mid-year election change that corresponds with elections a spouse made during his or her employer’s open enrollment period. However, the change in election must be consistent with the elections made by the spouse and be made effective going forward. The rules do not permit a mid-year election change to a Health FSA election.
Example: Employee works for Employer A. Employer A’s Section 125 plan runs January through December. During the last open enrollment, employee waived medical and dental coverage. Employee’s spouse works for Employer B. Employer B’s Section 125 plan runs August through July. When first hired, the employee’s spouse elected family coverage under the medical and dental plans. During the most recent open enrollment period, the spouse chose not to elect coverage under Employer B’s plan. Employer A may allow its employee to elect family coverage under the medical and dental plans offered by Employee A.
Do the IRS (Section 125) rules related to claim substantiation permit use of electronic payment cards with a health FSA?
Yes. IRS guidance permits the use of electronic payment cards (that is, debit cards, stored-value cards or credit cards) with Health FSAs, if certain requirements are satisfied to ensure proper claims substantiation. These requirements are described below.
Participants must agree in writing before receiving a card that they will:
- Only use the card to pay for their eligible medical care expenses (and those of their spouses and dependents);
- Not use the card for expenses that have already been reimbursed;
- Not seek reimbursement under any other health plan for expenses paid for with the card; and
- Acquire and keep sufficient documentation (for example, invoices and receipts) for expenses paid with the card.
In addition, the card must include a statement that these agreements are reaffirmed each time the participant uses the card. Thus, each time the card is used, the participant is affirming that the expense is eligible for reimbursement and will not be reimbursed elsewhere.
Card Use and Cancelation
The payment card’s balance or credit limit must not exceed the amount of the participant’s Health FSA coverage. In addition, the card must be automatically canceled when the employee no longer participates in the Health FSA.
Types of Health Care Merchants
The use of Health FSA electronic payment cards must be limited to the following three categories of merchants:
- Physicians, dentists, vision care offices, hospitals and other medical care providers, as identified by merchant category codes (MCCs);
- Stores with the “drug stores and pharmacies” MCC that, on a location-by-location basis, meet the 90 percent gross receipts test (qualifying pharmacies); and
- Stores that have implemented an inventory information approval system (IIAS).
Procedures for Claims Substantiation and Adjudication
Every Health FSA claim paid with an electronic payment card must be reviewed and substantiated, either automatically without additional documentation or manually through the submission of merchant or service provider receipts. Unlike health savings account (HSA) expenses, an employee cannot self-substantiate Health FSA expenses.
The following expenses at medical care providers and qualifying pharmacies are treated as automatically substantiated, and do not require any additional documentation:
- Transactions involving dollar amounts that match the copayments under the health plan covering the employee, spouse or dependents;
- Recurring expenses that match previously-approved expenses (for example, prescription refills); and
- Charges that were substantiated at the point of sale (real-time substantiation) by receipt of information from the service provider.
Auto-adjudication of card transactions at merchants without health care-related MCCs is permissible if an IIAS is in place to ensure that cards are used only for eligible medical care expenses and certain recordkeeping requirements are met. Electronic payment card transactions at medical providers and qualifying pharmacies that are not automatically substantiated can be treated as conditional and substantiated after the transaction.
The claim substantiation requirements cannot be met by simply sampling claims to determine if the reimbursement was appropriate. In addition, plans must have meaningful correction procedures for claims that are improperly paid from a Health FSA.
Special Rules for OTC Drugs
Under the health care reform law, effective Jan. 1, 2011, employees with a Health FSA cannot use their account funds to purchase OTC drugs unless they have a prescription for those items or the drug is insulin. If electronic payment cards are used to purchase OTC drugs, additional requirements must be met.
Effective after Jan. 15, 2011, Health FSA payment cards may continue to be used at drug stores and pharmacies, at non-health care merchants that have pharmacies and at mail order and web-based vendors that sell prescription drugs, if:
- Prior to purchase, the prescription for the OTC drug is presented to the pharmacist, the OTC medicine or drug is properly dispensed by the pharmacist and a prescription number is assigned;
- The pharmacy or other vendor retains a record of the prescription number, the name of the purchaser and the date and amount of the purchase in a manner that meets IRS recordkeeping requirements;
- All of these records are available to the employer or its agent upon request;
- The debit card system will not accept a charge for an OTC drug unless a prescription number has been assigned; and
- All other rules related to the use of Health FSA debit cards are satisfied.
Health FSA debit cards may also continue to be used for OTC drug purchases from health care providers other than pharmacies and mail order and web-based vendors if:
- The vendor has a health-care related MCC;
- The vendor retains the name of the purchaser and the date and amount of the purchase in a manner that meets IRS recordkeeping requirements;
- All of these records are available to the employer or its agent upon request; and
- All other rules related to the use of health FSA and HRA debit cards are satisfied.
If the requirements described above are satisfied, the transactions are considered fully substantiated at the point of sale. After Jan. 15, 2011, electronic payment cards may not be used to purchase OTC drugs at any other providers and merchants.