Medcom Blog

The Waiting Period Gamble & Nondiscrimination Testing Blog.jpg

The Waiting Period Gamble & Nondiscrimination Testing

The rules that govern nondiscrimination testing are often sources of confusion rather than clarity. That’s largely because many of them were written long before modern healthcare reform shaped today’s plan designs. To make things more complicated, different sections of the IRS code sometimes contradict each other, particularly around topics such as disparate waiting periods between employee classes.

One of the most debated areas? Whether employers can impose different waiting periods for different groups of employees, say, salaried vs. hourly, or workers in Dallas vs. New York.

The Gray Area in Section 125

The strictest commentators would argue that separate waiting periods should never be used. However, the IRS has left enough gray area within the Section 125 rules, compelling others to make the case for the permissive establishment of separate classifications based on “objective business criteria,” such as:

  • Employment type (salaried, hourly, full-time, part-time)
  • Job function (e.g., mechanics are covered, but the shipping department is not)
  • Geographic location (e.g., Dallas employees may participate, but New York employees may not)
  • Division, subsidiary, business unit, and profit-center distinctions

The Section 125 rules do not expressly preclude multiple waiting periods; thus, one could not say it is absolutely prohibited or non-compliant. But just because you can use them doesn’t mean it’s a good idea, because establishing more than one waiting period increases the likelihood of Section 125 nondiscrimination issues if testing reveals disproportionate advantages for highly compensated employees (HCEs).

For Section 125 plans, employers have occasionally chosen to implement separate waiting periods, and in some cases, this approach has caused no significant harm (although there may be ongoing exposure to tax consequences). For such employers, this is a gamble they are willing to live with.

Even if one year, everything looks fine and nondiscriminatory testing determines that the plan is not “discriminatory in design” due to the allocation of HCEs and non-HCEs within the classes, that can quickly change Turnover, changes to the compensation threshold of HCE determination, internal increases in compensation, etc., are all contributing factors that can all throw off your results the next year. That’s why annual testing is required.

Testing Self-Funded Plans

Conversely, disparate waiting periods are strictly prohibited under the guidelines written into the Section 105(h) Benefits Test. These rules for assessing self-funded medical plans specifically call for uniform waiting periods between classes on a prima facie basis.  However, this test is a fact and circumstances evaluation.  In the rare event that the non-highly compensated have a shorter waiting period, the test may pass this factor subjectively. Generally, a self-funded health plan with different waiting periods based on employee classification has a high likelihood of failing the Section 105(h) Benefits Test.

Failing the Test: What’s at Stake?

The consequences of failing the majority of tests under applicable nondiscrimination rules result in highly compensated employees losing or significantly reducing the tax exclusion under the plan, with the value of the excess tax advantage being added to their taxable income. This is referred to in the regulations as “excess reimbursement”.  The value of the excess reimbursement varies by the Code Section and the individual test failed. Corrections during the plan year are highly recommended.

Two Paths to Fix It

To make a correction, there are generally two options:

  1. Make the waiting period the same for all employee classifications.
  2. Make the coverage taxable for HCEs for the timeframe of difference in the waiting periods, which involves making the employee contributions after-tax and imputing income for the employer contribution.

In conclusion, when reviewing a plan with multiple waiting periods, this should raise a red flag for potential nondiscrimination issues and risks. Two waiting periods may work under the right circumstances; however, one waiting period is always the safest bet.


Stay Connected