When you terminate a management or executive employee, you might agree to pay all or part of their COBRA premiums for a period of time as part of a severance package. But can an employer pay COBRA premiums for an employee? And what compliance issues should you consider with employer paid COBRA severance?
Understanding employer-paid COBRA severance
Yes, employers can subsidize COBRA premiums for terminated employees, including executives, but there are important rules to follow. According to IRS regulations, these include proper COBRA notice and election procedures, how the subsidy affects eligibility for health coverage through the marketplace, and tax considerations under IRS Sections 125 and 409A¹.
If your group health plan is self-insured, tax and nondiscrimination rules can be more complex, especially if highly compensated individuals benefit disproportionately from COBRA subsidies. Fully insured plans generally face fewer nondiscrimination concerns, but it’s still important to consult legal or tax advisors when structuring COBRA severance arrangements.
Key compliance considerations
1. Follow COBRA notice and election procedures
Even if you pay 100% of the COBRA premiums, employees must complete a formal COBRA election. Failure to do so can cause issues with insurers or stop-loss carriers, potentially leaving you responsible for claims that should have been covered².
2. Marketplace enrollment after COBRA subsidy ends
COBRA subsidies usually last for a limited time. After the subsidy ends, the former employee may need to pay full COBRA premiums or seek coverage through the health insurance marketplace. However, the end of a COBRA subsidy is not always recognized as a special enrollment event for marketplace plans, which could limit enrollment options³.
3. Mid-year election events and new employment
If a former employee starts a new job, the expiration of a COBRA subsidy may not qualify as a mid-year election event to join the new employer’s plan on a pre-tax basis. This can affect their ability to switch coverage outside of open enrollment periods⁴.
4. Tax and nondiscrimination rules
For self-insured plans, IRS nondiscrimination rules under Section 105(h) apply and can be complicated when former executives receive COBRA subsidies. Additionally, severance agreements that include COBRA premium payments may be subject to deferred compensation rules under Section 409A, which have strict requirements⁵.
Simplifying COBRA severance arrangements
To avoid some of these complexities, some employers provide a lump sum payment to former employees. This allows them to purchase COBRA coverage or other insurance, such as through a spouse’s plan or the individual marketplace. Regardless of the approach, it’s critical to follow COBRA rules and consult legal or tax professionals.
If you’re considering employer-paid COBRA severance or want to understand how COBRA and severance packages work together, contact your Marsh McLennan Agency consultant for guidance.
Footnotes
1 IRS Sections 125 and 409A govern tax treatment of COBRA subsidies and severance payments.
2 Formal COBRA election is required even if premiums are fully subsidized.
3 Marketplace special enrollment rights may not apply when COBRA subsidies end.
4 COBRA subsidy expiration is generally not a qualifying mid-year election event under IRS rules.
5 Section 409A rules apply to deferred compensation, including some severance agreements.
