“Section 125” is a familiar term in the benefits world. Most brokers and employers know it governs pre-tax benefit plans, but far fewer fully understand the nondiscrimination requirements that come with it.
And that’s where issues can arise.
Failing a nondiscrimination test doesn’t invalidate the plan, but it does mean highly compensated employees could lose their tax advantages. That’s a conversation no employer wants to have after the fact.
Here’s what brokers need to know.
What Are Section 125 Nondiscrimination Tests?
The IRS requires Section 125 plans to pass three key nondiscrimination tests:
1. Eligibility Test
This test ensures the plan does not disproportionately favor highly compensated employees in terms of who is allowed to participate.
In simple terms:
Is the plan broadly available across the workforce?
2. Availability Test
This evaluates whether the benefits offered are equally accessible, not just technically available, but realistically usable.
Key question:
Are non-highly compensated employees able to take advantage of the same offerings?
3. Benefits Test
This examines whether highly compensated employees receive richer or more favorable benefits than others.
Bottom line:
The plan cannot provide disproportionate value to a select group.
Where Plans Commonly Go Wrong
Issues often arise when benefit structures unintentionally favor leadership or higher earners. Examples include:
- Executive carve-out programs
- Tiered benefit access
- Contribution structures that benefit higher salaries
Even when well-intentioned, these designs can trigger nondiscrimination failures.
Structuring Plans to Naturally Pass
The simplest way to avoid nondiscrimination issues?
Design plans that are inherently broad and equitable from the start.
A well-structured supplemental benefit program should:
- Be available to a wide employee population
- Offer consistent benefits across groups
- Avoid exclusive or tiered access
- Be easy for all employees to understand and enroll in
When these principles are built in, passing nondiscrimination tests becomes far less of a concern.
The Prodigy Approach
Prodigy programs are designed with compliance in mind, without adding complexity for brokers or employers.
By focusing on:
- Broad eligibility
- Uniform access
- Consistent benefit structures
These programs are aligned with the intent of Section 125 nondiscrimination rules from day one.
Why This Matters for Brokers
For brokers, understanding nondiscrimination is about protecting clients from downstream issues.
A plan that works on paper but fails testing can create:
- Unexpected tax consequences
- Administrative headaches
- Loss of trust with leadership teams
Helping clients implement benefit strategies that naturally align with IRS requirements is not only a value-add, but it’s essential.
