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Can an employer give better benefits or contributions to certain employees?

Whenever an employer wants to vary employer contributions or benefits for different classes of employees, and also allows pre-tax deductions through a cafeteria plan, the employer must consider the nondiscrimination rules under Section 125.

(Note- there are totally separate nondiscrimination rules under Section 105 that apply to self-insured plans, including level-funded plans, FSAs and HRAs, which will be reviewed under another blog post).

The Section 125 rules generally let employers vary employer contributions based on business-related classifications, as long as the variance doesn’t result in favoring those considered highly-compensated. For example, an employer could offer a higher employer contribution to managers than to rank and file employees, as long as the manager classification has more non-highly compensated than highly-compensated members.

An employer must perform nondiscrimination testing under the 125 rules to know for sure if their contribution, eligibility or benefits design somehow favors those defined as highly-compensated. Section 125 defines highly-compensated as any officer, more-than-5% owner/shareholder, or an employee making more than $125,000 (for 2019). So, the first step is to identify which individuals are considered highly-compensated because those individuals form the group that cannot be favored.  

After the employer has identified the group, the next step is to determine which classification is getting the better deal.

For example, if the employer pays 90% of the premium for managers and only 60% for the rank and file employees, the managers are clearly getting the better deal. To determine if this is considered discriminatory, the employer must determine whether that group has more highly-compensated than non-highly compensated members. If so, the plan design would probably violate the 125 nondiscrimination rules. If not, the plan design is not discriminatory and is fine under the rules.

In short, employers offering pre-tax benefits through a Section 125 plan may vary benefits or contributions by classification, but they’ll need perform nondiscrimination testing to avoid favoring highly-compensated individuals.  

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