Open enrollment aftermath: Addressing election errors

For employers with health and welfare plans that renew on a calendar year basis, it’s open enrollment season once again. And, despite all the planning that goes into making open enrollment a success — the  targeted communications, the employee meetings — it’s inevitable that, after open enrollment closes, employee questions like these will start to roll in: “I missed the deadline, can I still make an election?” “I picked the wrong plan, can I change my election?” “I didn’t realize I would be defaulted into a plan, can I drop coverage?” “I meant to elect FSA benefits, but I accidentally elected DCAP benefits,” and so on…  When dealing with these kinds of participant requests or enrollment errors, employers often are inclined to grant corrections, but before doing so it is important to understand all the rules that come into play.  How you respond to these kinds of requests should take into account the following considerations:

• Code Section 125 election change rules: Section 125 of the Internal Revenue Code of 1986, as amended (Code) establishes the rules by which an employee can choose between receiving compensation in cash or as qualified (i.e., pre-tax) benefits. The most common Section 125 benefits (also called “cafeteria plan” benefits) are pre-tax payment of premiums, health flexible spending account (FSA) benefits, and dependent care assistance program (DCAP) benefits. The general rule is that Section 125 elections, once made, must be irrevocable during the plan year (the “irrevocability rule”). Accordingly, the Section 125 rules permit mid-year election changes only under very limited circumstances. And, importantly, the Section 125 rules do not specifically allow for election changes to correct an error. Failing to strictly adhere to the Section 125 election change rules could result serious adverse tax consequences for both the employer and employees.

However, IRS officials have indicated — in informal, non-binding comments — that certain mistakes may be corrected if there is clear and convincing evidence of the mistake. For example, the employee elects $2,850 of FSA benefits during open enrollment, but a data entry error by the employer results in a $285 election being input into the system. This is clearly an employer error that the IRS likely would view as correctable without violating the irrevocability rule. Another example: an employee makes an election for DCAP benefits, but has no children or other qualifying dependents. This also may be a correctable error, depending on the facts and circumstances.

Accordingly, when considering an employee’s request to correct a mistaken election under a Section 125 plan, consider all the facts and circumstances: whose error was it — the employer’s or the employee’s? How far into the plan year is the correction request being made? (Corrections generally are more risky the farther into the plan year they are made.) Are there other facts or circumstances that indicate the election was truly made in error, as opposed to a circumvention of the irrevocability rule? And remember that the concept of correcting an election error under the Section 125 rules is based on informal, non-binding comments by IRS officials, and not authoritative IRS guidance. Accordingly, allowing a correction always comes with some risk that the IRS would disagree with your conclusion, and take enforcement action for violating the Section 125 election change rules.

• Plan terms: The Employee Retirement Income Security Act of 1974, as amended (“ERISA”) requires that employee benefit plans be administered in accordance with the terms of their written plan documents. Therefore, when you receive a request to change a plan election, you should also review the terms of the applicable plan document to determine if the change is permitted or is specifically prohibited. Also, some plans provide for a default enrollment if the employee fails to make an affirmative election, or they may provide for “evergreen” elections, which are elections that automatically carry over from one plan year to the next unless the employee changes them. Employers may consider calling out these types of provisions for employees during open enrollment to minimize the likelihood of errors or unintended enrollments.

• Insurance carrier requirements: How you respond to an employee’s request to change an election — particularly when it comes to adding coverage — should also be informed by whether the benefit plan at issue is fully-insured or self-funded.

In the case of a fully-insured plan (where the insurance carrier is responsible for funding the claims), the insurance carrier may not permit election changes outside of open enrollment because to do so would increase their financial risk. If a plan is fully-insured, the insurance carrier may need to grant approval before allowing any election change that falls outside of open enrollment or a required HIPAA special enrollment opportunity (i.e., following a loss of other coverage, the addition of a new dependent by marriage, birth, adoption, or placement for adoption, a loss of state Medicaid or children’s health insurance program (CHIP) eligibility, or becoming eligible for state premium assistance under Medicaid or CHIP).

If a plan is self-funded (meaning the employer pays the claims out of its own assets) then the employer may have somewhat greater latitude to allow election changes. However, if the employer maintains stop loss coverage to protect the company from the financial risk of large claims, approval from the stop loss carrier should be sought if the requested election change involves adding coverage (e.g., enrolling the employee, adding a dependent, or moving to a more generous plan option).

Regardless of the plan’s funding strategy, failure to seek carrier approval in these situation could result in the insurance carrier or stop loss carrier refusing to cover any claims that result from the election change.

• HSA contribution errors: Errors related to Health Savings Account (HSA) contributions are subject to their own set of IRS rules. The general rule is that HSA contributions are non-forfeitable, even if the employee consents to a return of the mistaken contribution, so HSA corrections are not a simple matter of requesting the return of the mistaken contribution.

However, the IRS recognizes three limited circumstances in which mistaken HSA contributions may be refunded (subject to the HSA trustee or custodian’s agreement to return the funds): First, if the individual was never eligible to receive HSA contributions in the first place. Second, where the employer mistakenly contributed more than the annual IRS-permitted maximum. And third, where there is “clear evidence of an administrative or process error,” such as when the employer sets the decimal position incorrectly, which results in a greater than intended contribution (e.g., instead of making an intended $500 contribution to an employee’s HSA, the employer mistakenly contributes $5,000.) Other examples of correctable administrative or process errors might include:

• an amount withheld and deposited in an employee’s HSA for a pay period that is greater than the amount shown on the employee’s HSA salary reduction election;
• an unintended employer contribution that occurred because an incorrect spreadsheet was accessed or because employees with similar names were confused with each other;
• an incorrect entry by a payroll administrator caused the incorrect amount to be withheld and contributed;
• a second HSA contribution received by an employee because duplicate payroll files were transmitted;
• an amount received by an employee because a change in employee payroll elections was not processed timely, so amounts withheld and contributed are different from what the employee elected; and
• an amount received because the HSA contribution amount was calculated incorrectly, such as when the employee elects a total contribution amount for the year, but it is allocated by the payroll system over an incorrect number of pay periods. (See IRS Information Letter 2018-0033.)

Read more: Know the IRS Rules for FSAs: 5 Questions to Ask

• Risk tolerance: Employers often want to help employees with these kinds of situations, but granting an employee’s request to change a mistaken election often places some amount of risk on the company — for example, the risk of IRS enforcement in the case of Section 125 plan election changes, or risk that an insurance carrier or stop loss carrier will refuse to cover any resulting claims. Some employers are comfortable assuming a certain amount of risk, others are highly risk-averse. Whatever your company’s risk tolerance, be sure you understand the potential risks of a given course of action, and be sure you have buy-in from company leadership for whichever approach you decide to take.

Kristine M. Bingman, Employee Benefits Attorney at Ogletree Deakins