The Loop

Reverse Discrimination in Employer Plans

Filed under: Benefits

Over the past couple of decades, many employers have attempted to recruit a more diverse workforce.
Given that the global economy is increasingly diverse, companies with a wider representation of the world's population tend to be better positioned to serve a broader customer base.

However, in an effort to reach more diverse populations, employers may inadvertently engage in reverse discrimination. This is when an employer seeks to subsidize lower-income employee benefits more than those with higher incomes. In this scenario, a lower-income worker may pay less while one who earns a higher income pays more for the same benefits. While the strategy may seem fair in the overall scope of compensation, it could qualify as an illegal practice that violates Title VII of the Civil Rights Act of 1964.

Reverse discrimination with regard to workplace benefits may apply to a wide range of issues, including race, gender, age, and income.

Executive Recruitment
Perhaps the most visible example of benefit differentiation concerns strategies for attracting and retaining executive workers versus that of the rank-and-file workforce. Employers must work within the scope of nondiscrimination rules to provide key benefits that may appeal to higher-income earners. In fact, the federal regulations and tax laws that apply to employee benefits make it quite difficult to offer proportionate value to executives with regard to group life insurance, disability insurance, and qualified retirement plans.

Life Insurance
For example, under a typical life insurance group plan, all workers may receive the same employer-sponsored benefit, such as two times their annual salary up to a specific limit. For the lower-income worker, the earned benefit may fall below the limit and still meet his family's needs. However, the calculation used to determine a life insurance benefit may not even include other sources of an executive's compensation, such as bonuses, dividends, commission, pensions, profit sharing or stock options. Moreover, the higher-income executive may not receive the full two times benefit because the amount exceeds the cap. Or, the higher-income executive will be taxed on the value of the insurance over the $50,000 annual cap set by the IRS.

In effect, this means that executives may not receive the same level of benefit as lower-earning workers. Since higher-income earners tend to lead a more upscale lifestyle commensurate with their earnings, the capped life insurance benefit may not be sufficient to provide the proportionate level of financial security that it would for a lower-income worker's family.

Fortunately, there are solutions to help employers offer a higher level of benefits so that executives are not subject to this form of reverse discrimination. For example, employers may offer the option for workers to purchase additional term or permanent life insurance for any executive(s) they choose. Under Section 162 of the Internal Revenue Code, the employer would pay the premium and take advantage of the annual tax deduction. The covered executive would be responsible for paying taxes on the annual premium, which in turn allows the death benefit proceeds to be distributed tax-free to the beneficiary.

An employer also is permitted to offer a split-dollar life insurance to key workers. With this program, the employer and the executive each pay a share of the premium and each receives a portion of the tax-free death benefit. This enables the employer to offer an enhanced benefit to higher-earning workers for better financial security for their families, as well as provide a financial bolster to help the company compensate for the loss of a key executive.

Long-Term Disability Insurance
As with life insurance, group long term disability (LTD) insurance is usually a percentage of each worker's individual monthly compensation, up to a capped monthly benefit limit. This capped monthly benefit often means that highly compensated workers receive a proportionately lower benefit. In this case, employers may offer supplemental insurance plans for an alternate "class" of employees that can feature different benefit limits and covered pay definitions. Either the employer can pay premiums for the supplement coverage, in which case the executive pays income taxes on the disability benefit; or, the executive can pay for premiums and the disability benefit is tax-free.

Retirement Benefits
A similar issue exists with employer-sponsored retirement plans. While highly compensated workers may need to save extra to support a more upscale lifestyle during retirement, the federal contribution limits for tax-deferred retirement plans are universal: $18,000/+6,000 for those over age 50 (2016 and 2017) and $53,000+6,000 for those over age 50 (for 2016; $54,000 for 2017) in total contributions by the worker and employer combined.

In fact, these federal limits inherently discriminate against highly compensated employees (HCE) who earn more than $120,000 a year. The total contribution an employer can make to HCEs is limited based on the overall 401(k) plan participation rate. In other words, there must be a substantial number of rank-and-file workers contributing to the plan or it could be construed as a benefit only for high earners. If this happens, the HCEs may receive a portion of their contributions back.

However, in an effort to not discriminate against lower-earning workers, this federal limit creates a reverse discrimination scenario for HCEs who have the means and need to save more for retirement.

Much like life and disability insurance, there are enhanced retirement savings options that employers can offer to higher-earning workers to offset this seeming reverse discrimination. These include nonqualified deferred compensation plans such as a:

• Supplemental Executive Retirement Plan (SERP): An agreement between the employer and the worker that the company will pay a certain benefit at a later date (generally at retirement), for a number of years as a supplement to their retirement; it also may include a survivor benefit in the event of the worker's premature death.

• Section 162 Bonus Plan: The employer pays the worker a bonus plus an additional amount to cover the tax on the additional compensation. The plan is owned by the worker, but may include a feature to limit access to further plan accumulations if he leaves the company early.

• A 401(k) Mirror Plan permits highly paid top executives to contribute on a non-qualified, but tax-deferred basis, to a plan with identical investment options as the company's qualified 401(k) plan.

• Salary Continuation Plan: Replaces an executive's income in the event of his/her retirement, disability or death; may require a certain number of years of employment before eligibility.

Domestic-Partner Benefits
For many years, most medium and large employers have offered benefits for same-sex domestic partners such as health, dental, and vision insurance; sick and bereavement leave; accident and life insurance; death benefits; and parental leave. Now that same-sex marriage is legal in all 50 states, some companies may revert back to offering these benefits only to married couples, regardless of gender. However, employers that retain unmarried same-sex domestic partner benefits but don't have opposite-sex domestic partner benefits could face a legitimate threat of reverse discrimination. Going forward, employers may want to consider offering domestic partner benefits to couples of both or either sex, or not offer them at all.

Healthcare Benefits
The Patient Protection and Affordable Care Act mandates employer healthcare coverage benefits to all workers based on the number of full and part-time workers. However, there are certain healthcare benefits that can be offered to enhance benefits. For example:

• Health Reimbursement Arrangement (HRA): An employer contributes to individual health spending accounts for each worker to reimburse out-of-pocket medical and dental expenses, including premiums paid. These accounts are employer-owned and funded; they are not portable. However, contributions are 100 percent tax deductible to the employer and tax-free for the employee.
HRAs must be offered alongside a high deductible healthcare plan.
• Executive Medical Exams: Some companies offer free annual physicals to their executives that include comprehensive medical screenings (e.g., stress tests, fitness evaluations, additional diagnostic testing) not typically included in an annual physical.

Affirmative Action
We generally hear about discrimination in the workplace related to minority race, gender, and age demographics – not how it may impact wealthier workers. However, the increased complexity of regulation and tax rules associated with mandated and optional benefits makes it more likely for employers to create reverse discrimination without even realizing it.

The Supreme Court has made various rulings in recent years that clarify the intents and purposes of certain types of affirmative action programs to ensure that they do not produce reverse discrimination lawsuits. It's important to understand the various types of strategies employers utilize to offset the potential for reverse discrimination of highly compensated employees, or work with benefit plan experts who do.

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