Self-insured plans have to contend with 105 nondiscrimination rules

If an employer decides to vary employer contributions based on business-related classifications, they are generally allowed to do so as long as the results don't favor highly compensated individuals (HCIs). However, there are 2 different types of rules that apply to specific types of plans: Section 125 and Section 105(h) nondiscrimination rules.

As mentioned in our previous blog, Section 125 applies whenever an employer allows pre-tax salary reductions through a cafeteria plan. Section 105, however, applies to self-insured medical plans (including HRAs and health FSAs), but does not apply to fully insured medical plans as of yet -- as a reminder, the ACA extended the 105 rules to fully-insured plans, but the IRS has since postponed implementation indefinitely. Thus, an employer with a self-insured plan that allows pre-tax deductions would need to contend with both sets of rules.

When 105 and 125 rules apply, the employer must perform nondiscrimination testing under both rules to know if the employer contribution, eligibility or benefits design somehow favors highly-comped individuals (HCIs). However, each set of rules uses a different definition of HCI.

An HCI under Section 125 is any officer, a more-than-5% owner or an employee making more than $125,000 (for 2019). But an HCI under Section 105 is any top 5 paid officers, a more-than-10% owner or shareholder, or the highest-paid 25% of employees. So, once an employer determines which individuals are HCIs, then those individuals form the group of HCIs who cannot be favored.

Once they’ve determined which group has HCIs in it, they’d next need to see who is getting the better deal. For example, if an employer contributes 90% for managers and only 75% for hourly employees, the managers are the group getting the better deal. If that group of managers has more HCIs than non-HCIs, the benefit design is favoring HCIs, and would be considered discriminatory. However, if more non-HCIs than HCIs are the manager class, the plan design probably isn’t discriminatory.

Lastly, the Section 105 rules don’t allow any benefit level to be based on age, compensation or years of service. For example, if a group of longer-tenured employees received a better employer contribution than less-tenured employees, this would likely violate the 105 benefits test. Also, HCIs cannot be favored by getting shorter waiting periods. Plans must ensure benefit designs are not discriminatory, which can only be known through required testing.