Flexible Employer Contributions: Legal Ways to Offer Tiered or Defined-Contribution Models

Introduction

One of the most common questions we hear from small business owners is straightforward: “Can we offer different health insurance contribution levels to different employees?” The answer isn’t a simple yes or no—it depends on your structure and whether you’re following IRS nondiscrimination rules.

Many small employers struggle with this challenge. You might want to contribute more for full-time employees than part-timers. You may need to adjust contributions based on employee classification or geographic location. Or perhaps you’re trying to encourage employees to choose lower-cost plans.

The good news? There are legal, compliant ways to accomplish flexible contribution strategies. This guide walks through your options, the rules governing them, and practical implementation advice.

Understanding the Nondiscrimination Baseline

Before exploring flexible contribution models, you need to understand a fundamental compliance principle: the IRS prohibits health benefit discrimination based on protected characteristics (status, salary, or job classification—with limited exceptions).

Under IRC Section 105(h), group health plans cannot discriminate in eligibility or benefits. This applies to:

• Individual coverage HRAs (ICHRAs)
• Health Reimbursement Accounts (HRAs)
• Health Flexible Spending Accounts (FSAs)
• Traditional group health plans (self-funded or fully insured)

The IRS divides discrimination rules into two categories:

Eligibility discrimination: Whether employees can enroll in the plan Benefits discrimination: The type or amount of coverage provided

Understanding these distinctions is critical because some contribution strategies are permissible while others are not.

Strategy 1: Individual Coverage HRAs (ICHRAs)

An Individual Coverage Health Reimbursement Arrangement is one of the most flexible contribution models available to small employers. The ICHRA was formalized by the Trump administration in 2019 and refined through IRS guidance ever since.

How ICHRAs Work

With an ICHRA, you provide employees with a fixed monthly allowance (say, $300-$600) that they use to purchase individual health insurance on the ACA marketplace. The employee owns the policy, and unused funds typically roll over year-to-year (though you can structure them to expire).

The Flexibility Advantage

ICHRAs allow permissible employee classifications without triggering nondiscrimination concerns:

• Full-time vs. part-time employees
• Different contribution amounts by class
• Different vesting schedules
• Geographic-based contributions

For example, you could offer: - $500/month for full-time employees - $250/month for part-time employees (20+ hours/week) - $350/month for remote employees in high cost-of-living areas

Important caveat: You cannot classify based on age, gender, health status, or other protected characteristics.

Compliance Considerations

ICHRAs require: 1. Written plan document 2. Individual notice to each employee (at least 30 days before effective date) 3. Clear communication about enrollment deadlines 4. Coordination with employee’s ACA subsidy eligibility

One nuance: ICHRA participants may be eligible for ACA subsidies. The subsidy calculation becomes more complex but isn’t a deal-breaker—many employers find the flexibility worth the administrative lift.

Strategy 2: Traditional HRAs with Proper Nondiscrimination Testing

A Health Reimbursement Account (HRA) paired with group health insurance can offer contribution flexibility if structured correctly.

Testing Requirements

Unlike ICHRAs, traditional HRAs require nondiscrimination testing under IRC Section 105(h). The test examines:

1. Eligibility test: At least 70% of all employees (or 80% of those eligible) must be eligible for benefits
2. Benefits test: Benefits and coverage cannot unfairly favor highly compensated employees

Permissible Tiering Strategies

Within traditional HRA structures, you can differentiate contributions based on:

• Employee classification (full-time/part-time, salaried/hourly)
• Length of service (vesting schedules)
• Position/department (if applied consistently to similarly-situated employees)

You cannot differentiate based on: - Individual salary amounts - Health status or claims history - Age - Gender or other protected classes

Practical Example

A 20-person manufacturing company structures its HRA as follows:

• Full-time employees: $300/month HRA + group plan
• Part-time employees (20+ hrs/week): $150/month HRA + group plan
• Part-time employees (<20 hrs/week): Not eligible

As long as the classification is clearly defined and applied uniformly, this passes nondiscrimination testing.

Strategy 3: Defined Contribution Plans with Group Coverage

Some employers use a “defined contribution” model where they allocate a fixed dollar amount per employee, and employees select from plan options at that price point.

How It Works

Instead of “we’ll pay 80% of premiums,” you say “we’ll contribute $400/month, period.” Employees choose plans within their budget or pay the difference.

Compliance Advantages

• Predictable employer costs
• Employees see true cost of coverage
• Can be applied consistently across classifications
• Easier to administer than complex subsidy calculations

The Limitation

While defined contribution sounds flexible, it must still comply with nondiscrimination rules. You cannot offer different contribution amounts to different individuals based on protected characteristics, though contribution differences by employee classification (full-time/part-time, job category) are permissible.

Strategy 4: Tiered Premium Sharing

The most traditional approach remains tiered cost-sharing based on coverage level:

• Employee only: Company pays 85%, employee pays 15%
• Employee + spouse: Company pays 75%, employee pays 25%
• Family: Company pays 70%, employee pays 30%

This model is widely accepted and compliant because: - The tiers apply uniformly to all employees - Contribution percentage doesn’t depend on salary, health, or protected status - It encourages plan shopping without discrimination

Key Compliance Do’s and Don’ts

✅ DO

• Document everything: Written plan documents, eligibility classifications, and contribution schedules
• Apply rules consistently: If part-time means <30 hours/week, apply it uniformly
• Communicate clearly: Employees should understand why contribution levels differ
• Review annually: Ensure classifications remain valid and non-discriminatory
• Consult a professional: Run nondiscrimination testing if using traditional HRAs

❌ DON’T

• Base contributions on individual salary: This triggers discrimination concerns
• Exclude employees arbitrarily: Classification must be clearly defined in writing
• Change rules mid-year without notice: Give employees reasonable advance notice
• Assume ACA rules don’t apply: Even with group coverage, ACA affordability standards matter
• Ignore COBRA implications: Your contribution strategy affects COBRA premium obligations

Which Strategy Is Right for You?

Choose ICHRAs if:

• You want maximum flexibility in contribution amounts
• You have diverse employee classifications (remote, part-time, full-time)
• You prefer employees own their health insurance policies
• You want simplicity in administration

Choose Traditional HRAs if:

• You offer group health coverage and want supplemental reimbursement
• Your workforce is fairly homogeneous
• You’re willing to conduct nondiscrimination testing
• You want a more traditional benefits approach

Choose Defined Contribution if:

• You want predictable, fixed costs
• You want employees to actively choose plans
• Your workforce is stable and classified clearly
• You prefer transparency in contribution amounts

Choose Tiered Premium Sharing if:

• You offer group coverage and want simplicity
• You want universal applicability across all employees
• You prefer traditional cost-sharing approaches

Implementation Best Practices

1. Audit your current setup: Ensure existing contribution strategies are compliant
2. Create written documentation: Plan documents, eligibility rules, and contribution schedules
3. Communicate with employees: Clarity prevents confusion and complaints
4. Train HR and payroll staff: They need to understand and apply rules consistently
5. Review annually: Business changes may require plan modifications
6. Maintain records: Documentation protects you in case of IRS inquiry

Conclusion

Flexible employer contributions aren’t just possible—they’re increasingly practical with modern tools like ICHRAs. The key is choosing a strategy aligned with your business structure and applying it consistently while respecting nondiscrimination rules.

Whether you’re a five-person startup or a 100-person manufacturer, there’s a compliant path to flexible benefits. The investment in proper structuring pays dividends in employee satisfaction, cost control, and audit protection.

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Nexus Benefit Solutions is an independent employee benefits advisory firm based in West Michigan. Questions? Reach out at jason@nexusbenefitsolutions.com or call 616-425-9740.