Failure alert! Plan sponsors who forget to actually do discrimination testing run into all sorts of problems, including the possibility that their plan can be disqualified. Employee health plans, like cafeteria plans and self-funded welfare benefit plans have to do annual discrimination testing to remain qualified. Insured health plans will eventually be subject to discrimination testing, but they have a reprieve for now. Size doesn't matter.
To pass the Section 105(h) nondiscrimination rules an employer must meet two separate tests:
- The Benefits Test
- The Eligibility Test
The benefits test measures whether the plan is "offered in a manner that is discriminatory on its face" and whether the plan is operated "in a discriminatory manner." All benefits provided for highly compensated employees (HCEs) must be provided for all other participants” and that “all the benefits available for the dependents of HCEs must also be available on the same basis for dependents of all non-HCE participants.” Required employee contributions must be the same for HCEs and non-HCEs for each benefit level and the same type of benefits that are available to HCEs must be available to non-HCEs.
The "discrimination in operation" occurs, for example, if a plan added a benefit for a particular treatment for one plan year during which an HCE received coverage for that treatment, then terminated the benefits as soon as the HCE no longer needed the treatment.
Confused yet? How about the eligibility test...
An employer passes the eligibility test if it passes any one of the three:
- At least 70% of employees must benefit from the plan.
- If at least 70% of all non-excludable employees are eligible, the plan benefits at least 80% of the eligible employees.
- The plan benefits a nondiscriminatory classification of employees. This test requires (1) eligibility based on a bona fide business classification, and (2) a sufficient ratio of benefiting non-HCEs to benefiting HCEs.
Plan sponsors who skip testing run into trouble because they can't report they are non-discriminatory. Plan sponsors that test incorrectly might have a failing plan and not know it. Then benefits become taxable as income.
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