Question: Are there nondiscrimination rules that apply to group-term life insurance benefits?
Short Answer: Yes, Section 79 imposes nondiscrimination rules that generally require employers to offer non-key employees the same level of coverage as offered to key employees.
Section 79 Nondiscrimination: General Rule
The nondiscrimination rules that apply to group-term life insurance plans generally require that employers not make available a greater coverage amount (whether a flat dollar amount or based on a percentage of compensation) to key employees than is made available to non-key employees.
In other words, the type and amount of benefits provided under a group-term life insurance plan generally must be available on the same terms to key employees and non-key employees.
There are two main components to Section 79 nondiscrimination testing:
- Eligibility Test: Employers must offer group-term life insurance coverage based on nondiscriminatory eligibility classifications; and
- Benefits Test: Employers must make available to non-key employees all group-term life insurance benefits that are made available to key employees.
Key Employee Status
A key employee is defined as:
- An officer making at least $180k annually (2019);
- A more than 5% owner; or
- A more than 1% owner making at least $150k.
The Eligibility Test
The general rule is that the employer can create group-term life insurance eligibility groups based on classifications that are reasonable and not discriminatory in favor of key employees.
Employers that would like to create certain classes of employees that are eligible and ineligible for the group-term life insurance benefits should attempt to design the classes with a significant cross section of both key employees and non-key employees to avoid any scrutiny. Employers can exclude short-term, part-time, and seasonal employees from this analysis.
The Benefits Test
Employers must make available to non-key employees all group-term life insurance benefits that are made available to key employees. On review, the IRS would determine whether a plan discriminates based on all the facts and circumstances of the arrangements.
Making group-term life insurance coverage levels available on the basis of a percentage of compensation is permitted, even if key employees disproportionately elect to enroll in the coverage.
Discriminatory Plan Consequences
Providing additional group-term life insurance coverage to a key employee that is not available to non-key employees would make the plan discriminatory. There are numerous adverse tax consequences for key employees if the company violates the nondiscrimination rules.
The primary consequence is that key employees will be taxed on the first $50,000 of group-term life insurance coverage—which is otherwise excluded from employees’ income. Key employees will also be taxed on the greater of the Table 1 value of coverage or the actual cost (per a specific formula) of the cost of coverage, which will be subject to additional FICA payroll taxes.
Group Term Life Plan Designs that Avoid Nondiscrimination Issues
Most employer group-term life plans are designed to offer a flat dollar amount of coverage for all full-time employees, or coverage up to a percentage of compensation (typically up to a cap) for all full-time employees. These typical plan designs avoid any potential nondiscrimination issues.
(d) Nondiscrimination requirements.
(1) In general.
In the case of a discriminatory group-term life insurance plan
(A) subsection (a)(1) shall not apply with respect to any key employee, and
(B) the cost of group-term life insurance on the life of any key employee shall be the greater of—
(i) such cost determined without regard to subsection (c), or
(ii) such cost determined with regard to subsection (c).
(2) Discriminatory group-term life insurance plan.
For purposes of this subsection, the term “discriminatory group-term life insurance plan” means any plan of an employer for providing group-term life insurance unless—
(A) the plan does not discriminate in favor of key employees as to eligibility to participate, and
(B) the type and amount of benefits available under the plan do not discriminate in favor of participants who are key employees.
(3) Nondiscriminatory eligibility classification.
(A) In general. A plan does not meet requirements of subparagraph (A) of paragraph (2) unless—
(i) such plan benefits 70 percent or more of all employees of the employer,
(ii) at least 85 percent of all employees who are participants under the plan are not key employees,
(iii) such plan benefits such employees as qualify under a classification set up by the employer and found by the Secretary not to be discriminatory in favor of key employees, or
(iv) in the case of a plan which is part of a cafeteria plan, the requirements of section 125 are met.
(B) Exclusion of certain employees. For purposes of subparagraph (A), there may be excluded from consideration—
(i) employees who have not completed 3 years of service;
(ii) part-time or seasonal employees;
(iii) employees not included in the plan who are included in a unit of employees covered by an agreement between employee representatives and one or more employers which the Secretary finds to be a collective bargaining agreement, if the benefits provided under the plan were the subject of good faith bargaining between such employee representatives and such employer or employers; and
(iv) employees who are nonresident aliens and who receive no earned income (within the meaning of section 911(d)(2)) from the employer which constitutes income from sources within the United States (within the meaning of section 861(a)(3)).
(4) Nondiscriminatory benefits.
A plan does not meet the requirements of paragraph (2)(B) unless all benefits available to participants who are key employees are available to all other participants.
(5) Special rule.
A plan shall not fail to meet the requirements of paragraph (2)(B) merely because the amount of life insurance on behalf of the employees under the plan bears a uniform relationship to the total compensation or the basic or regular rate of compensation of such employees.
(6) Key employee defined.
For purposes of this subsection, the term “key employee” has the meaning given to such term by paragraph (1) of section 416(i). Such term also includes any former employee if such employee when he retired or separated from service was a key employee.
(1) Key employee.
(A) In general. The term “key employee” means an employee who, at any time during the plan year, is—
(i) an officer of the employer having an annual compensation greater than $130,000,
(ii) a 5-percent owner of the employer, or
(iii) a 1-percent owner of the employer having an annual compensation from the employer of more than $150,000.
IRS Notice 2018-83:
The dollar limitation under § 416(i)(1)(A)(i) concerning the definition of “key employee” in a top-heavy plan is increased from $175,000 to $180,000.
Temp. Treas. Reg. §1.79-4T:
Q-. 9. Under what circumstances will the amount of benefits available under a plan of group-term life insurance be considered not to discriminate in favor of participants who are key employees?
A-9. A plan of group-term life insurance will be considered not to discriminate in favor of participants who are key employees, as to the amount of benefits available, if the plan provides a fixed amount of insurance which is the same for all covered employees. In other circumstances, the determination of whether a plan is nondiscriminatory will be based on all of the facts and circumstances.
Q-. 10. How is additional coverage purchased by employees under a plan of group-term life insurance treated for purposes of determining whether a plan of group-term life insurance is discriminatory?
A-10. (a) The extent to which employees purchase additional coverage under a plan of group-term life insurance is not taken into account for purposes of determining whether a plan of group-term life insurance is discriminatory. For example, a plan providing insurance to all employees of 1 times annual compensation, which gives all employees the option to purchase additional insurance of 1 times annual compensation at their own expense, would not be considered discriminatory as to the type and amount of benefits available, even if the group (or groups) of participants who purchase additional insurance, if tested separately, would not satisfy the requirements of section 79(d)(2)(A). Solely for this purpose, the choice of an amount of group-term life insurance as a benefit under a cafeteria plan will be treated as the purchase of group-term life insurance by an employee. If additional insurance coverage is available to any key employee that is not available, on a nondiscriminatory basis, to non-key employees, the plan will be considered discriminatory, even if the full cost of such additional insurance coverage is paid by the employee(s) electing such benefits.
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