Flexible Benefits Training What is a Cafeteria Plan? What is a Cafeteria Plan? Created by Revenue Act of 1978. A cafeteria plan (flexible spending account) provides one way for an employer to deliver a non-taxable benefit to employees. A cafeteria plan must allow for the selection between at least one nontaxable (qualified) benefit and at least one taxable (permitted) benefit. The taxable benefit is generally an employee s salary, or earned income. 2 What is a Cafeteria Plan? Defined contribution plan. Fixed employer contributions. The IRS considers all contributions to a cafeteria plan to be employer contributions. That is generally why the employee does not pay taxes on contributions tib ti to the plan. The Department of Labor (DOL) considers contributions to a cafeteria plan to be employee funds, and therefore plan assets. 3 1
What is a Cafeteria Plan? IRC Reg. Section 1.125-1(a)(1): The term cafeteria plan means a separate written plan that complies with the requirements of section 125 and the regulations, that is maintained by an employer for the benefit of its employees and that is operated in compliance with the requirements of section 125 and the regulations. All participants in a cafeteria plan must be employees. A cafeteria plan must offer at least one permitted taxable benefit (as defined in paragraph (a)(2) of this section) and at least one qualified benefit (as defined in paragraph (a)(3) of this section). A cafeteria plan must not provide for deferral of compensation (except as specifically permitted in paragraph (o) of this section). 4 What is a Cafeteria Plan? Cafeteria plans do not change the taxability of any benefit. IRC Section 125 allows salary redirection for a benefit that could have been offered on a nontaxable basis through the employer (i.e. employer- paid health insurance premiums). Exclusions from income are contained in the various IRS code sections that may be offered through a cafeteria plan. 5 Eligible Benefits Permitted Taxable Benefits Cash (compensation) Property Benefits that are currently taxable (i.e. paid time off) Benefits purchased with after-tax tax dollars 6 2
Eligible Benefits Qualified Benefits Employer sponsored group term life ($50,000) Accident and health insurance Premiums for COBRA Accidental death and dismemberment Long- and short-term disability 401(k) contributions Certain plans maintained by educational organizations Health care Dependent care assistance Individually-owned policy premiums Adoption assistance Health Savings Account (HSA) contributions 7 How Does it Work? Employee makes irrevocable annual election before beginning of plan year. Contributions withheld from payroll are tax-free dollars banked by employer for future reimbursement. Claim filed by participant for expenses as they are incurred, or the participant uses a debit card. Reimbursement, for claim form, of tax-free dollars for qualifying expenses that are not reimbursed by any other plan. Cannot defer compensation (contributions from one year used to purchase a benefit in a subsequent year). 8 Employer Savings FICA savings of 7.65% Insurance premiums may be reduced for coverages, such as worker s compensation and disability insurance, that are based on employees taxable salaries. Retirement plan expenses may be reduced. Lower health insurance costs. Increase employee s share of insurance premiums. Administrative costs are tax-deductible and can be paid by the employer, the employees, or a combination. 9 3
Employee Savings Contributions withheld are not subject to federal, social security, most state taxes, and some local taxes. (FICA will be paid on contributions to the adoption and 401(k) portions of the plan.) Employee can budget for health care costs. 10 Constructive Receipt Earned income (cash) is taxable unless there is an IRS tax exclusion from income. Irrevocable elections. Certain changes allowed in elections. If the cafeteria plan contains nonqualified benefits, then all benefits are taxable. Regardless if the participant selected an otherwise non-taxable benefit. If the salary redirection (cafeteria plan contribution) is considered to have been constructively received by an employee, the cash is considered to have been received as taxable income. 11 Employer Challenges Uniform Coverage In the health care account means that a participant s annual election is available to them at all times during the plan year, regardless of contributions received to date. Cash flow Risk of loss if employee terminates 12 4
Employer Challenges Plan design options: Reduce maximum contribution limitations. Make eligibility requirements more stringent. Not allow participants to make election revocations or modifications upon changes in status. Limit types of expenses that can be reimbursed (exclude large dollar items such as orthodontia). Reduce grace period for terminated employees to turn in claims after termination. 13 Employer Challenges Financial benefit to employers: FICA savings Forfeitures could help offset losses Grace period will reduce forfeitures Use-it-or-lose-it might go away 14 Plan Design Does employer currently have a plan? Decide whether to amend and restate current plan document or start new plan. Terminate old plan be sure to file a final Form 5500 if required. Amend old plan need original effective date and plan number used for previous Form 5500 filing and/or plan document. 15 5
Plan Design Plan years may not be more then 12 months, but can have a first, short plan year. Short plan year for bona-fide business reason such as aligning the cafeteria plan with the employersponsored health plan. Can have two, consecutive short plan years, but it should be rare. Best to have FSA year the same as the health insurance plan year. 16 Plan Design Participant's annual election to Health FSA cannot be changed mid year because of a change in insurance benefits or premiums. 401(k) offered through a cafeteria plan. FICA paid on contributions to the 401(k) Changes to contribution amount ruled by 401(k) May help pass the 25% concentration test Employer flex dollars may be used by participants for their 401(k) The flex dollars must be available in cash if 401(k) is option under the cafeteria plan 17 Plan Document Commonwealths Virginia Massachusetts Pennsylvania Kentucky U.S. Virgin Islands 18 6
Plan Document Eligibility requirements for FSA plan can generally be the same as those needed to join the health insurance program. Premiums paid for health insurance can then be paid on a pre-tax basis and elections to all plans are made at the same time. The plan document must include description of benefits, eligibility rules, procedures for participant elections and terminations, plan year details, and information about employer and employee contributions. 19 Plan Document Who sets the limits for the plan? Health FSA unlimited amount with some restrictions, set by the employer. Dependent Care - $5,000 for married filing jointly and single head of household. $2,500 for married filing separately, set by IRS. Adoption - $12,170 (2010), with some restrictions, set by the IRS and indexed each taxable year. 20 Plan Document Who sets the limits for the plan? HSA - $3,050 (single) $6,150 (family), $1,000 catch up (), with some restrictions, set by the IRS and indexed each taxable year. 401(k) - $16,500, $5,500 catch up (), set by the IRS and indexed each taxable year. Individually-owned policy premiums unlimited amount with some restrictions, set by the employer. 21 7
Plan Document Who sets the limits for the plan? Long and short-term disability premiums benefit set by the carrier. Health insurance policy premiums limit sufficient to support the policy premiums. 22 Changes in Elections Reg. Section 1.125-4 Final Regulations The regulations provide an exhaustive list of qualified benefits that would permit an election change. Regulations offer two-pronged approach to determining when change may be made to existing election: A change in status or a change in cost or coverage occurs, and Election change satisfies consistency rule 23 Seven circumstances apply to accident or health plans (including health FSAs), disability, group-term life insurance plans, dependent care assistance, and adoption assistance plans: 1. Special enrollment rights under Health Insurance Portability and Accountability Act (HIPAA). Allows election changes on prospective basis in event of marriage (a HIPAA event). Retroactive election changes can be made for HIPAA events of birth, adoption, or placement for adoption if change is requested within 30 days of event 24 8
1. Special enrollment rights under Health Insurance Portability and Accountability Act (HIPAA). Termination of coverage due to loss of eligibility under Medicaid or state-sponsored Children s Health Insurance Program (CHIP) Eligibility for employment assistance under Medicaid or CHIP to help pay for coverage under the employer health plan. Retroactive enrollment allowed if change is requested within 60 days of event. 25 2. Change in status events Change in legal marital status. Marriage, death of spouse, divorce, legal separation, and annulment. Change in number of dependents. Birth, death, adoption, and placement for adoption. Change in employment status. Any event that changes employment status of employee, employee s spouse, or employee s dependent: termination or commencement of employment, strike or lockout, commencement of or return from unpaid leave of absence, or change in worksite. If employee, spouse, or dependent becomes (or ceases to be) eligible under a Cafeteria Plan or other employee benefit plan of the employer of employee, spouse, or dependent. 26 2. Change in status events (cont.) A. Dependent satisfies or ceases to satisfy eligibility requirements. This change can occur because of attainment of age, student status, or similar circumstance. B. Change in residence. For example: employee, spouse, or dependent moves in or out of Health Maintenance Organization (HMO) coverage area. C. Adoption. Proceedings begin or terminate under adoption assistance program. 27 9
3. Judgment, decree, or order. A conforming election change can be made that results from divorce, legal separation, annulment, or change in legal custody (including a qualified medical child support order). Such a change would allow an increase to election if the order provided coverage; or, would allow participant to cancel coverage if the order required another to provide coverage and it was, in fact, provided by another. 4. Entitlement to Medicare or Medicaid. Gain or loss of eligibility would allow participant to decrease election under an accident or health plan. 28 5. Significant cost or coverage changes. Four events apply to accident or health plans (not including Health FSAs), disability, group-term life insurance plans, dependent care assistance plans, and adoption assistance plans: A. Cost changes: 1) Automatic cost changes, such as cost of qualified benefits plan increasing or decreasing; and 2) significant cost changes. If cost increases significantly, employee may revoke election and elect coverage under another benefit package option or drop coverage under accident and health plan if no other benefit package option is offered. If cost decreases significantly, employee may commence participation in the Cafeteria Plan for the option with a decrease in cost. 29 Significant cost or coverage changes (cont.) Coverage changes, such as significant curtailment of coverage under a plan, allow participants to revoke elections and receive, on a prospective basis, coverage under another benefit package option that provides similar coverage. A loss of coverage* permits participants to revoke elections and elect coverage under another benefit package option or drop coverage under the accident and health plan if no other benefit package option is offered. * A loss of coverage means a complete loss of coverage including elimination of a benefits package option, an HMO ceasing to be available in the area, by reaching an overall lifetime or annual limitation, a substantial decrease in availability of medical care providers, a reduction in benefits for specific type of medical condition or treatment, or any other similar fundamental loss of coverage. 30 10
5. Significant cost or coverage changes (cont.) C. A coverage change is made under another employer plan. Includes changes made during open enrollment period or valid change of status of spouse or dependent. D. A loss of coverage for employee, spouse, or dependent under any group health coverage sponsored by governmental or educational institution, including: 1) State-run children s health insurance program (SCHIP) 2) Medical care program of an Indian tribal government, the Indian Health Service, or a tribal organization 3) State health benefits risk pool 4) Foreign government group health plan 31 6. Family and Medical Leave Act (FMLA). Employees may revoke existing election for group health plan coverage and make another election for remaining portion of the period of coverage as provided under FMLA. 7. 401(k) plans. Elections may be modified or revoked in accordance with 401(k) plan regulations. 32 Coverage change that adds to or improves existing benefit package option allows eligible employees to revoke their elections under the Cafeteria Plan and elect coverage under new or improved benefit package. Includes employees with no previous election under Cafeteria Plan. These cost or coverage events include situations in which an employee switches between full- and part-time work (and eligibility is affected), or an employer changes percentage of premium that an employee must pay, or a new benefit option is added. Cost charged to employee is key factor in determining whether cost change has occurred. 33 11
Second part of the equation deals with whether election change satisfies the consistency rule. Consistency rule applies to each employee, spouse, or dependent separately, and requires that election change be on account of and correspond with a change in status that affects eligibility under an employer s plan (see exception). Includes an increase or decrease in number of an employee s family members or dependents who may benefit from application under the plan. Change occurs when an employee, spouse, or dependent gains or loses coverage eligibility for accident or health coverage and group-term life insurance. So, a spouse that goes on unpaid leave of absence, where no eligibility change takes place, would not constitute a reason for participant to change insurance elections. 34 When participant gains coverage under another employer s plan and revokes his or her election, a certification that coverage was actually selected should be obtained from employee. While regulations allow participants to revoke their election and receive, on a prospective basis, coverage under another similar benefit package option, that coverage need not be provided d by participant s i t employer. A plan may treat coverage by another employer, such as that of a spouse or dependent, as similar coverage. Change-in-cost-or-coverage regulations do not apply to Health FSAs, the unreimbursed medical portion of a Cafeteria Plan. Employees may only change an election to a Health FSA if a valid change of status occurs and resulting election change satisfies the consistency rule. 35 Determine that a valid change in status occurred. Eligibility was affected. The change requested is on account of and corresponds with reason for change. Participant s spouse terminates employment and loses dental coverage. Can the participant change their Health FSA election? Yes Spouse s employer drops dental coverage. Can the participant change their Health FSA election? No 36 12
Implementation An employer does not have to allow participant election changes in their plan. Employers may pick and choose which changes they will and will not allow. 37 Family Medical Leave Act Final Reg. Section 1.125-3 Employee can change election when beginning or returning from a FMLA leave. Employee is responsible for contributions while on leave. Employer must make contributions to the plan as well. This would not be a COBRA qualifying event. https://www.mhmresources.com/doc/ff/mhmr- FF0110a-FMLAandCafeteriaPlans.pdf 38 Family Medical Leave Act Big Picture Continue Coverage Pre-pay Pay-as-you-go Catch-up Revoke Coverage, and upon return Reinstate Prorate 39 13
Family Medical Leave Act Three payment options available to continue coverage: Pre-Pay. Employee pays contribution before leave begins. Contributions may be done pre-tax. Contributions pre-paid in one plan year cannot be applied to new plan year. Pay-as-you-go. Employee pays contributions during leave. Contributions are usually done after tax, but may be pre-tax if employee receives compensation from sick days or vacation days. Catch-up. Employee pays contributions upon return from leave. Contributions may be done pre-tax. Arrangements must be made prior to employee going on FMLA. Employer can offer one or more payment option. However, pre-pay cannot be the only option available. If catch-up is the only option, employees on non-fmla leave must also have this option. 40 Family Medical Leave Act Plan Document: Upon return from such leave, that has been or is being paid for under one of the methods referred to above, the Employee will be permitted to re-enter the Plan on the same basis the Employee was participating in the Plan prior to the leave, or as otherwise required by the FMLA. However, for the Health Care Reimbursement Plan, if the coverage terminates due to revocation of the Benefit or due to nonpayment of contributions by the Participant, two options will be offered upon the Participant s return to work. 41 Family Medical Leave Act Proration. The actual amounts contributed by the Participant would remain in effect for the duration of the Plan Year, but the expenses incurred by the Participant during the lapse in coverage period would not be reimbursable and the maximum contribution amount would be reduced proportionately for the time that the Participant was not paying Premiums. Reinstatement. The plan may require that an employee whose health coverage was terminated during the unpaid FMLA to reinstate the level of coverage in effect when the leave began, with applicable contribution amounts being made up for the remainder of the Plan Year. The maximum coverage level will remain in effect from the Participant s Election. In either scenario, the employee is not covered for the time they are on unpaid FMLA leave. 42 14
Family and Medical Leave Act Example Annual election (24 pay periods) $1,200 Contributed prior to FMLA 1/1 to 4/30 $ 400 (8 pay periods) Disbursed prior to FMLA $ 600 FMLA from 5/1 to 7/31 6 pay periods Number of pay periods remaining 10 43 Family and Medical Leave Act Proration A new annual election is determined by prorating the original annual election for the months the participant was absent. Annual election minus 6 pays ($1,200 minus $300) equals $900 new annual election. New annual election reduced by prior reimbursement ($900 minus $600) equals $300. The per pay remains the same at $50 per pay. Contributions equal $900 ($400 plus $500) with an employer exposure of $900 ($600 plus $300). Participant is not covered during their leave. 44 Family and Medical Leave Act Reinstate Annual election remains at the original annual election of $1,200. Annual election minus reimbursed to date ($1,200 minus $600) equals $600 New per pay will increase to $80. They are making up the missed contributions. Contributions equal $1,200 [$400 plus $800($80 X 10)] The employer exposure of $1,200 ($600 plus $600). Participant is not covered during their leave. 45 15
FSE Flexible Spending Extended Period of Coverage IRS Notice 2005-42 Deferred compensation interpretation change not a change in the IRS code. The period of time in which a qualified expense can be incurred may be extended up to the 15th day of the third month following the plan year end. Employer must amend plan document before plan year end. 46 FSE Flexible Spending Extended Period of Coverage Expenses incurred during this grace period may be paid with leftover funds from the previous year. If an employee is eligible and not terminated on the last day of the plan year, the entire grace period is afforded to the employee even through they may terminate t during the grace period. For one or all benefits within the plan. Grace period and Run out period. 47 Flexible Benefits Training What is a Cafeteria Plan? 16