Potential Benefits Pitfalls: Adding Classes to Benefits

Definition of a Bona Fide Class

In the context of benefits compliance (especially for Section 125 Cafeteria Plans, Group Health Plans, and certain other employee benefit plans), a bona fide classification means a group of employees that is distinguished by objective, non-discriminatory criteria that are clearly defined in the plan document.

• Objective Criteria: The class must be defined by factors that are clearly verifiable and based on the nature of the employment. Examples of bona fide classifications include:

  • Job Title/Function: Full-Time vs. Part-Time, Salaried vs. Hourly, Managers vs. Non-Managers, Executives.

  • Geographic Location: Employees in State A vs. Employees in State B.

  • Length of Service: Employees with 5+ years of service.

  • Compensation: Highly Compensated Employees (HCEs) vs. Non-Highly Compensated Employees (NHCEs) (though this is a test, not a classification for all rules).

• Non-Discriminatory Intent: The classification must not be drawn in a way that disproportionately favors Highly Compensated Employees (HCEs) over Non-Highly Compensated Employees (NHCEs) in its design or operation.

In the situation with your employee: If you have a bona fide class called “People Managers” that is entitled to specific benefits, the employee must meet the objective definition of that class to receive those benefits. Once their role changes and they are no longer a “People Manager,” they would naturally fall out of that classification and move to the appropriate new classification (e.g., “Non-Management Employee”).

Potential Compliance Issues (Failure to Follow the Law)

Allowing a single employee to retain benefits they no longer qualify for, while denying them to others in the same new classification, can result in serious compliance risks related to both Non-Discrimination Rules and Fiduciary Duties.

A. Non-Discrimination Rules (IRC Sections 105, 125, etc.)

Many employee benefits, particularly self-insured health plans and Section 125 Cafeteria Plans, must pass non-discrimination tests. Treating one individual differently from others in the same bona fide class (or lack of classification) can be viewed as discriminatory in operation against other, similarly situated employees.

• Risk: If the IRS determines that your plan is discriminatory in operation because you are selectively granting benefits outside of the established classification rules:

  • Self-Insured Health Plans (IRC $S 105(h)$): All HCEs who participate in the discriminatory plan could have the value of the discriminatory benefit included in their taxable income.

  • Section 125 Cafeteria Plans: The plan could fail the non-discrimination tests, resulting in all HCEs having all of their pre-tax elections (e.g., health premiums, FSA contributions) being treated as taxable income.

B. Breach of Fiduciary Duty (ERISA)

For benefits covered by ERISA (like group health plans), administrators have a fiduciary duty to act prudently and solely in the interest of the plan participants and beneficiaries.

• Risk: Failing to administer the plan according to its written terms (which define the bona fide classes) can be considered a breach of fiduciary duty.

  • Consistent Application: Fiduciaries must apply the plan rules consistently and equally to all participants. Granting an exception to one employee is a failure of this duty and could expose the employer or the specific plan administrator to personal liability for participant losses or for penalties.

  • Plan Integrity: Allowing discretionary exceptions undermines the integrity of the plan documents, which are the foundational legal rules governing the benefits.

C. Employee Morale and Litigation Risk

• Risk: Granting an exception to one former manager creates a precedent and a basis for others to demand similar treatment. This creates significant employee relations problems and can increase the risk of an employee lawsuit alleging unfair treatment or discrimination.

✅ Recommendation

To ensure compliance, you should move forward with the plan to adjust the employee’s benefits to match their new role classification.

1. Refer to the Plan Document: Confirm the exact language in your official Summary Plan Description (SPD) and/or plan document that defines eligibility for the “management benefits.”

2. Apply the Rule: Document that the employee no longer meets the objective, bona fide criteria for that classification.

3. Communicate: Explain to the employee that, while you value their service, federal law (ERISA/IRS non-discrimination rules) requires the company to administer benefits consistently according to the established bona fide classes defined in the plan. Allowing an exception would place the company and the plan at significant financial and legal risk.