By: HUB’s EB Compliance Team
Employers with a workforce that has varying levels of compensation sometimes find themselves in an awkward position. To satisfy the Affordable Care Act’s employer mandate, they have to offer affordable coverage, but affordable for a lower paid worker can mean a heavy subsidy for a higher paid worker. To address this, some employers look at tiering health plan contributions by income.
The Affordable Care Act’s employer mandate, requires applicable large employers to offer at least one health plan that provides affordable, minimum value coverage to its full-time employees (and minimum essential coverage to their dependents) to avoid penalties. For employers with lower paid populations, this often means the employer must contribute a significant amount towards the total cost of coverage to ensure the employee portion is affordable.
What’s an employer to do when it has employees earning $10 per hour as well as $100,000 or more per year? One option is to offer all employees the same benefits at the same employee contribution rates. To make sure the offer of coverage was affordable for all employees, the employer would calculate affordability based on either the Federal Poverty Level safe harbor, or the Rate of Pay safe harbor using the $10 per hour their lowest paid employee earns.
The main downside of this approach is that the employer must contribute a higher percentage of the total premium for their entire eligible population, even though higher earning employees could pay higher rates and coverage would still be affordable.
A Different Approach
One possible solution to address this is to offer the same coverage to all employees, while increasing employee contributions for higher earning employees. This strategy is commonly referred to as “tiering contributions based on income” or “determining benefits costs based on salary bands”. Employers looking at this type of contribution strategy typically divide their contribution rates into compensation bands. Employee contributions are then determined based on what band the employee falls into. The number of bands used and the income ranges for each band will be determined by the employer. Most employers use two to five bands. Here is one possible example:
|Employee Income||Less than $25k||$25,001 - $50,000||$50,001 - $75,000||Over $75,000|
|Employee Rate Per Month||$75.00||$110.00||$110.00||$200.00|
In the example above, the employer contributes less towards the coverage for higher earning employees, while still ensuring coverage is affordable for each compensation band. Depending on the number of employees in each compensation band, the employer’s savings may be significant.
Note that employer sponsored benefit plans may be subject to one or more non-discrimination rules under Sections 125 or 105(h) of the Internal Revenue Code. Which rule(s) apply depend on whether the benefit is paid for on a pre- or post-tax basis, and whether the plan is fully-insured or self-insured. While these rules prohibit discrimination in favor of highly-compensated employees, tiering contributions as described above would generally not violate these rules as long as the tiers are based on total compensation.
While an employer may save money with this strategy, it’s important to consider the potential downsides of this approach. First, if an employer currently has one rate that’s applicable to all eligible employees, moving to a tiered system will likely result in some employees “winning” by paying less than they currently do, and others “losing” by paying more (possibly significantly so) than current rates.
This strategy also means that employees may move between salary bands year over year as merit or other increases may push salaries from one bracket to the next. This can be particularly difficult when an employee’s salary is just barely in a bracket. Using our sample bands above, if an employee earning $49,000 receives a 3% merit increase, their salary jumps to $50,470. This salary increase of nearly $1,500 loses its luster when the employee realizes they’ll be paying $480 more for the same health coverage they had previously.
Relatedly, employers should do their best to ensure that the additional required contribution does not completely eat up a bonus or typical raise. Employers can do this by setting the salary band contributions close together. However, that will reduce the employer’s savings. Alternatively, they can manage their compensation process to try and prevent an employee from receiving a raise or bonus that pushes them just over into the next compensation band.
Employers with employees in multiple geographic areas may also see difficulties in implementing this type of strategy. The cost of living can vary considerably across the United States. Simply said, $75,000 in a location with a high cost of living does not go as far as $75,000 in a location with a lower cost of living. Employees in high cost of living areas may feel as if they are being penalized for living in high cost of living areas since they would also be required to pay more for health insurance.
From a nondiscrimination perspective, it is also important to include total compensation, as defined in applicable nondiscrimination rules. Basing bands solely on salary, for example, could create a potential nondiscrimination issue. In that case, if an employee receives a bonus that makes them “highly compensated” under an applicable nondiscrimination test, but their contribution does not increase, the employer could have a “highly compensated” employee (including the bonus) paying less than a non-highly compensated employee (who did not receive a bonus). This would create an unintentional discrimination issue.
Here are some next steps employers can take when examining such a strategy:
- Understand the administrative work that goes into establishing different benefits rates for different employees within their payroll system.
- Determine the number of bands to be implemented. More bands generally equals more administrative work. Employers will generally want a significant number of employees in each band to justify the administrative work involved.
- Evaluate individual salaries for employees with salaries at or near the bottom of each band and determine what, if any, geographic issues may exist between areas with high and low costs of living and how they may impact employees.
NOTICE OF DISCLAIMER
The information herein is intended to be educational only and is based on information that is generally available. HUB International makes no representation or warranty as to its accuracy and is not obligated to update the information should it change in the future. The information is not intended to be legal or tax advice. Consult your attorney and/or professional advisor as to your organization’s specific circumstances and legal, tax or other requirements.