Can employers still vary employer contributions for different classes of employees? And will the Section 105 nondiscrimination rules ever apply to fully insured plans?

Any time an employer wants to vary contribution amounts for different classes of employees, the employer must consider two sets of nondiscrimination rules: IRC Sections 105 and 125. Generally speaking, those two sets of rules allow employers to vary employer contributions based on business-related classifications, so long as the result of the variance does not favor highly compensated individuals (HCIs). As an example, the employer could offer a higher contribution to its office employees than to its factory employees, so long as the office employee population is made up of a majority of non-HCIs.

Before going further, though, it’s helpful to review which rules apply to which plans. Section 105 applies now to self-insured medical plans (including HRAs and health FSAs), but does not apply to fully insured medical plans. As most know, the PPACA made 105 applicable to fully insured plans, but the IRS delayed implementation of that requirement (and it likely won’t apply any time soon since the Trump Administration is not interested in PPACA enforcement). Section 125 applies if employees are allowed to contribute towards coverage on a pre-tax basis via salary reduction. So, employers might have to contend with both sets of rules (for example, a self-insured plan towards which employees can contribute premium payments pre-tax) or neither set of rules (for example, a fully insured plan for which the employer contributes 100 percent of the premium cost).

If either 105 or 125 apply, though, the employer will have to run the nondiscrimination tests to know if their contribution, eligibility and benefits structure somehow favors HCIs. An HCI under 125 is any officer, a more-than-5 percent owner or an employee making more than $120,000 (for 2017). An HCI under 105 is a top-5-paid officer, a more-than-10 percent owner or an employee in the top-25 percent of all employees with respect to compensation. So, the first step is identifying which individuals are HCIs. Those individuals form the group of HCIs in whose favor the contribution structure cannot discriminate.

Once the employer has identified that HCI group, the next step is identifying which group or classification of employees is getting the better deal. For example, if the employer is offering 75 percent employer contributions for the office employees and only 50 percent for the factory employees, the employer will identify the office employees as the group getting the better deal. The last step is determining whether that group has more HCIs than non-HCIs. If so, the plan design is likely favoring HCIs, meaning it will violate the nondiscrimination rules. If not, the plan design is likely fine under the nondiscrimination rules.

So, employers are still allowed to vary employer contribution levels. But they will need to take steps to understand and run the related nondiscrimination tests to avoid favoring HCIs. If structured properly, an employer can vary contributions without violating those rules.

Lastly, it’s not likely that 105 will apply to fully insured plans in the near future—with the PPACA in limbo, it’s unlikely the new presidential administration would enforce it (and it’s possible the Republican replacement plan will either repeal that provision or replace it with something else altogether).