Jun 04, 2025
The Risk of Employers Making Benefit Plan Exceptions
Employers occasionally run into scenarios for which they consider making benefit exceptions. For example, waiving waiting periods, permitting mid-year changes outside of what §125 rules permit, allowing ineligible individuals to participate in benefits, accepting COBRA elections or payments beyond designated deadlines, or covering excluded benefits.
Often employers are trying to help employees by making an exception, but before doing so, the employer should understand the potential compliance risks of doing so and weigh such risks against the benefit of making an exception. Sometimes an employer will decide to “bend” a rule for the right reason.
ERISA
The Employee Retirement Income Security Act (ERISA) imposes fiduciary responsibilities on employers and plan sponsors.
ERISA mandates that a plan be administered "in the interest of the participants and beneficiaries" and "in accordance with the documents and instruments governing the plan."
Allowing exceptions, while often well-intentioned, can inadvertently harm other plan participants and expose the employer to fiduciary risks under ERISA. Deviating from the plan’s terms—such as by allowing ineligible individuals to remain enrolled, waiving waiting periods, or covering normally denied benefits—can undermine the integrity and equity of the plan. Financially, these exceptions may increase the plan’s costs, which can ultimately affect all participants through higher premiums, reduced benefits, or increased cost-sharing.
Most importantly, ERISA fiduciaries are required to act solely in the interest of all plan participants and to administer the plan in accordance with its terms. Granting exceptions risks breaching this fiduciary duty, especially if the decision benefits one individual at the expense of the plan or other participants. Such actions could also result in the employer being fully responsible for claims coverage due to the unavailability of carrier or stop-loss coverage.
§125 Election Change Rules
Under §125 rules, a pre-tax election is irrevocable for the plan year unless the employee experiences an event found in the regulations as allowing a mid-year election change (e.g., change in employment status, marriage, enrollment in Medicare, change in cost of coverage). Even when changes are permitted, the election change is generally only permitted to be prospective.
Outside of what is permitted under §125 election change rules, there are sometimes situations in which an exception is appropriate. Although the employer would not be required to allow a mid-year change without a recognized event, sometimes the employer would prefer to do so when unique scenarios present themselves.
While an occasional exception to §125 election change rules is unlikely to pose any significant risk, an employer who allows frequent exceptions risks the tax-favored status of the employer’s §125 cafeteria plan for all participants.
COBRA
After a qualifying event (e.g., termination of employment or loss of dependent status), the employer or plan administrator must provide a COBRA election notice to the qualified beneficiary. The qualified beneficiary then has 60 days from the date the notice is sent or the date coverage is lost, whichever is later, to elect COBRA continuation coverage. Once COBRA coverage is elected, the qualified beneficiary has 45 days from the date of election to make the first premium payment, and subsequent monthly premiums must typically be paid within a 30-day grace period from the due date.
Allowing exceptions to COBRA timelines (e.g., allowing late elections or accepting late premium payments) can set a precedent that may create confusion and potential legal challenges from other qualified beneficiaries who may expect similar leniency.
Health insurance carriers, administrators and stop-loss vendors may refuse to cooperate with exceptions to COBRA timelines. By sticking to COBRA election and payment timelines, employers can ensure compliance with federal regulations, maintain consistency in their benefits administration, and avoid potential legal and financial risks.
Nondiscrimination Rules
Title VII, other EEOC laws (e.g., the Americans with Disabilities Act (ADA)), and HIPAA nondiscrimination rules prevent employers from discriminating against employees based on a protected class such as race, sex, disability, or health status.
Carving out exceptions could potentially lead to claims of such discrimination. For this reason, employers are generally discouraged from treating employees differently on an individual basis.
In addition, specific benefit nondiscrimination rules (e.g., §125, §105(h), §129 and §79) restrict an employer’s ability to provide tax-advantaged benefits to employees in a manner that discriminates in favor of highly compensated individuals (HCIs) and key employees.
These rules do not require employers to treat everyone the same, but benefit exceptions made only for HCIs or key employees could trigger tax liability and tax-related penalties for both the employer and affected HCIs and key employees.
Setting Precedent
Employers sometimes face benefits decisions where they wish to make an exception based on an employee’s specific facts and circumstances.
While there is concern that making one exception may require similar treatment for other employees going forward, many plan documents allow limited discretion for exceptions. In addition, granting one exception does not give other employees an automatic right to the same; nor does it have a high risk of setting precedent and requiring the employer to make exceptions for all employees going forward. Even so, employers should avoid making routine exceptions to minimize legal risk.
It is strongly recommend that employers document the specific circumstances surrounding exceptions made in the event another employee finds themselves in similar circumstances (in which case making the same exception may be appropriate).
Summary
Nothing stated herein should be interpreted as a recommendation to make exceptions or disregard plan language and relevant rules and regulations. Plan exceptions should be the exception rather than the rule.
However, there are instances where employers may need to make exceptions for valid reasons. Understanding the actual risk associated with a particular situation will enable employers to make informed and prudent business decisions.
While every effort has been taken in compiling this information to ensure that its contents are totally accurate, neither the publisher nor the author can accept liability for any inaccuracies or changed circumstances of any information herein or for the consequences of any reliance placed upon it. This publication is distributed on the understanding that the publisher is not engaged in rendering legal, accounting, or other professional advice or services. Readers should always seek professional advice before entering into any commitments.
