Premium Only Discrimination Issue

[Guest gaham]

Lets say you have a premium only cafeteria plan for converting employee contributions for health plan benefits to pre-tax instead of post-tax contributions and your health plan is an insured plan. If the employer pays the entire premium for highly compensated employees but only pays a portion of the total premium for every other employee, do you have a discriminatory 125 plan? Obviously, the HCEs don't need the 125 plan and won't use it. We could gross up the HCEs (ie increase there salary so that they must elect like the nonHCEs) but we don't want to do that if we don't have to.

[Guest Harry O]

Doesn't matter . . .

Even though your medical program is not self-insured and subject to the dreaded section 105(h), it does discriminate in favor of high-paid employees by virtue of its premium structure. That is not a problem under section 105(h) but it does preclude you from utilizing section 125 to pay these discriminatory premiums on a pre-tax basis.

Section 125© provides that a section 125 plan will be nondiscriminatory where qualified benefits (medical insurance coverage in your case) *OR EMPLOYER CONTRIBUTIONS ALLOCABLE TO [MEDICAL BENEFITS]* do not discriminate in favor of highly compensated participants.

You wouldn't argue (or would you?) that employee premiums for an executive-only insured medical plan could be paid on a pre-tax basis through a section 125 plan?!

[KIP KRAUS]

I think the bigger question may be "do you have a descriminatory medical plan"? There has to be some non-descriminatory definition of eligibility to receive medical benefits at no employee cost. I would not think that basing such eligiblity soley on being highly compensated would qualify as non-descriminatory. For instance, do some salaried employees have to pay while others don't? This would concern me first, then I'd worry about the pre-tax premiums.

[Guest gaham]

Kip, please note that the medical plan in question is NOT a self-insured medical plan subject to nondiscrimination rules. It is an insured arrangement and, therefore, not subject to discrimination concerns. See. Reg. Sec. 1.105-11.

[Guest GBMcGrath]

Harry O - Literally, I see where you're coming from. However, the way to fix the nondiscrimination problem is to eliminate the cafeteria plan, and simply require the rank-and-file employees to pay for their insured medical benefits with after-tax dollars. The execs still have their pre-tax benefit under the insured plan, and the only ones harmed by the elimination of the plan are the ones the nondiscrimination rules were meant to protect in the first place. Why not just design the cafeteria plan for nonhighlys only? It seems to me that 125© could be read as "employer contributions [to the cafeteria plan]allocable to qualified benefits..."

[Guest jamesfdavis]

I like GBMcGrath's second idea - set up the Cafeteria Plan for NHCEs only. How does this structure sound?:

- Set up two ERISA health plans, one for HCEs and one for NHCEs.

- Amend the Cafeteria Plan so it funds only the NHCE health plan.

- Further fence apart the funding of the two plans by negotiating with the carrier to experience rate them separately so that NHCE surpluses can not subsidize HCE deficits.

- In future years, remember why you did all of this, in case you're tempted to change to self-funding or change carriers. If you change carriers, make sure the new one buys into separate experience rating before awarding the business. If you self-fund the NHCE plan, keep the HCE plan insured to avoid 105(h) problems.

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Jim Davis

[This message has been edited by jamesfdavis (edited 02-12-99).]

[KIP KRAUS]

gaham:

Grossing up the HCEs may be the best strategy, provided the gross up does not outweigh the savings to the employer on his matching fica contributions for the non-HCEs.

[Guest ESOPwizard]

Suppose that you go ahead with one health plan and one cafeteria plan.

What are the odds that the IRS is going to assert that the 125 plan is

discriminatory under sec 125©? (after you remind the Service that the

sole consequence of a determination that the plan is discriminatory would

be to tax the non-HCEs)