Understanding Federal Nondiscrimination Laws for Group Health Benefits

What Employers Need to Know About Health Plan Compliance

Federal law prohibits discrimination in employee benefit plans, but not all benefit types are treated equally. While retirement plans have their own complex rules, group health and welfare benefits fall under a separate set of nondiscrimination standards that employers must understand to remain compliant.

In this article, we focus exclusively on health benefit discrimination rules, including what’s allowed, what’s prohibited, and how to stay compliant with federal laws like ERISA, HIPAA, and the Internal Revenue Code.

Key Terms

ERISA: Employee Retirement Income Security Act
Enacted in 1974, ERISA sets minimum standards for employee benefit plans offered by private employers, including health and welfare benefit plans. ERISA also prohibits discriminatory or retaliatory practices that interfere with benefit rights.

HIPAA: Health Insurance Portability and Accountability Act
Passed in 1996, HIPAA includes nondiscrimination rules that prohibit group health plans from denying eligibility or charging different premiums based on health status, medical conditions, or history, subject to specific regulatory exceptions such as compliant wellness program rules.

ERISA: Protecting Health Benefit Rights

Under Section 510 of ERISA, employers may not interfere with an employee’s right to participate in a benefit plan.

Prohibited actions include:

  • Terminating an employee because they have high-cost medical claims
  • Reducing an employee’s hours to make them ineligible for coverage
  • Disciplining or firing someone for using health benefits
  • Retaliating against employees who provide testimony in an ERISA-related proceeding

ERISA doesn’t require employers to offer health benefits, but if they do, they cannot take adverse employment action to prevent someone from obtaining benefits or exercising their rights.

HIPAA: Nondiscrimination Based on Health Factors

HIPAA bars group health plans from discriminating against individuals based on health status-related factors. These rules generally apply within groups of “similarly situated individuals,” meaning a plan can use bona fide employment-based classifications, but it cannot treat people differently within a classification because of a health factor. eCFR+1

Employers can:

  • Change carriers or plan designs (for example, switch to an HMO)
  • Increase deductibles or copays, as long as changes apply consistently to the covered group
  • Apply uniform plan rules regardless of medical conditions
  • Offer compliant wellness program incentives, when the program is made available to all similarly situated individuals and required accommodations are provided Federal Register+1

Employers cannot:

  • Deny or restrict eligibility based on an employee’s illness or expected healthcare costs
    Charge a higher premium to an individual because of claims history or medical condition, within a similarly situated group eCFR+1
  • Terminate or pressure an employee to drop coverage due to expensive medical needs
  • Reduce hours or target employees for employment actions based solely on health status

Even during layoffs or restructuring, employers may not target employees for termination because of costly health conditions.

Internal Revenue Code: Nondiscrimination in Tax-Advantaged Plans

Group health plans that are self-funded, or offered through pre-tax payroll arrangements, can trigger additional IRS nondiscrimination rules. The key point is that different rules apply depending on how the benefit is funded and how employees pay for it.

Self-Funded Plans Under Section 105(h)

If your medical plan is self-funded, it must comply with nondiscrimination rules under Code Section 105(h). These rules are designed to prevent self-funded plans from favoring Highly Compensated Individuals (HCIs) in eligibility or benefits. U.S. Code+2GovInfo+2

Section 125 Cafeteria Plans 

If employees pay for benefits on a pre-tax basis through a Section 125 cafeteria plan, the cafeteria plan itself must satisfy nondiscrimination requirements. In practice, these tests are designed to ensure that pre-tax benefit access and elections do not disproportionately favor Highly Compensated Employees (HCEs) or key employees.

HCE vs HCI: What Employers Should Know

These terms sound similar, but they are not interchangeable. Mixing them up is a common compliance mistake.

HCI, used for self-funded medical plan testing under Section 105(h)

A Highly Compensated Individual generally includes: 

  • One of the five highest paid officers
  • A shareholder who owns more than 10 percent in value of the employer’s stock
  • An individual in the highest paid 25 percent of employees

HCE, used for Section 125 cafeteria plan testing

A Highly Compensated Employee is a separate IRS definition commonly used in benefit plan testing. In general, an HCE includes:

  • A 5 percent owner (directly or indirectly) regardless of compensation, or
  • An employee whose compensation exceeded the IRS threshold in the lookback year

For plan years beginning in 2026, the IRS threshold used in the definition of HCE remains $160,000

Why this distinction matters

  • Section 105(h) nondiscrimination testing applies to self-funded medical benefits and uses the HCI definition.
  • Section 125 nondiscrimination testing applies to the pre-tax cafeteria plan arrangement and uses the HCE concept.

Key Takeaways for Employers

  • ERISA protects employees from retaliation or interference related to benefit rights.
  • HIPAA prohibits eligibility and premium discrimination based on health status-related factors among similarly situated individuals, with limited exceptions such as compliant wellness programs. 
  • IRS nondiscrimination rules apply differently depending on whether the medical plan is self-funded (105(h), HCIs) or offered through a cafeteria plan (125, HCEs).
  • Design changes are allowed, but they must be applied consistently and cannot target individuals based on health status.
  • Discrimination based on high claims, chronic illness, or perceived cost to the plan is prohibited.

Smart Benefit Plans Meet Guidelines, Employee Needs, and Employer Cost-Containment Goals

If you’re offering group health benefits, nondiscrimination compliance isn’t optional, it’s federal law. While flexibility in plan design is permitted, those choices must be made fairly and applied consistently across the workforce.

Need help reviewing your health benefit design for 2026? Parker Insurance works with mid-market employers to ensure compliance while offering practical, affordable benefits that work for employers and employees.compliance while offering practical, affordable benefits that work for employers and employees.