How to Structure ICHRA Allowances: 2026 Compliance Rules

TL;DR

ICHRA nondiscrimination rules require employers to offer the same allowance to every employee within a defined class, with only two permitted variations: age (capped at a 3:1 ratio) and family size. Employers can choose from 11 IRS-approved employee classes and set different allowance amounts between classes. A premiums-only ICHRA is exempt from Section 105(h) nondiscrimination testing, which is one of the most overlooked compliance shortcuts available. Applicable large employers must also pass ACA affordability or face penalties of up to $5,010 per employee in 2026.

ICHRA adoption among employers grew 34% for ALEs and 52% for small businesses between 2024 and 2025, according to the HRA Council’s 2025 report. That growth means thousands of employers are setting allowances for the first time and asking a straightforward question: how do I stay compliant?

The answer sits at the intersection of the June 2019 ICHRA Final Rule, Section 105(h) of the Internal Revenue Code, and ACA employer mandate requirements. Get the structure right, and you have a flexible, tax-advantaged benefit. Get it wrong, and you face plan disqualification or IRS penalties that can reach thousands of dollars per employee.

This guide walks through every rule that governs how to structure ICHRA allowances to comply with nondiscrimination rules, with concrete dollar amounts, worked examples, and a compliance checklist you can use before your next plan year.

Schedule a demo to see how automated class setup and allowance configuration can simplify compliance from the start.

What Are ICHRA Nondiscrimination Rules?

ICHRA nondiscrimination rules are the federal requirements that prevent employers from designing their health reimbursement arrangement to favor highly compensated individuals (HCIs) over rank-and-file employees. These rules draw from two sources:

1. The ICHRA Final Rule (June 2019), which created a class-based “same terms” framework specifically for ICHRAs.
2. Section 105(h) of the Internal Revenue Code, which imposes eligibility and benefits testing on self-insured health plans, though with a critical exception for premiums-only ICHRAs (more on that below).

The distinction matters. Traditional group plans use 105(h) testing to evaluate whether a plan discriminates in favor of HCIs across the entire company. ICHRAs take a different approach: compliance is measured within each employee class, not company-wide. This class-based structure gives employers meaningful flexibility in how they allocate allowances across different workforce segments, as long as every employee inside a given class receives the benefit on the same terms.

Understanding these rules is foundational for anyone adopting an ICHRA for the first time.

The “Same Terms” Requirement: The Core Rule

The single most important rule for structuring ICHRA allowances is this: within each employee class, every employee must receive the ICHRA on the same terms.

That means if you define “full-time employees” as a class and offer them $500 per month, every full-time employee in that class gets $500 per month. You cannot give one full-time employee $400 and another $600 based on job title, tenure, performance, or any other factor.

Two Permitted Variations Within a Class

The rules carve out exactly two ways you can vary allowances within the same class:

Age. Employers may offer higher monthly amounts to older employees, reflecting the reality that individual market premiums increase with age. The maximum allowance offered to the oldest employee in a class cannot exceed three times the amount offered to the youngest. This 3:1 ratio mirrors the age-rating bands used in the ACA individual market.

Family size. Employers can increase allowances for employees who cover a spouse or dependents, since family coverage costs more than individual coverage. This variation must apply consistently to everyone in the class.

Beyond age and family size, nothing else justifies a different allowance within the same class.

What’s Explicitly Prohibited

Two categories of variation are always off-limits, regardless of how classes are structured:

Percentage-of-premium reimbursements. An employer cannot reimburse a percentage of each employee’s actual individual market premium. Because premiums vary by plan choice, carrier, and location, this approach would produce different effective allowances for employees in the same class.

Health-status-based adjustments. Offering a larger allowance to an employee because they have diabetes, a chronic condition, or any other adverse health factor violates nondiscrimination rules. Allowances cannot function as a proxy for expected claims.

These prohibitions exist to prevent the kind of targeted generosity that would undermine the purpose of a class-based system. For more on how to design eligibility criteria that stay within the rules, see our detailed guide.

When Does Section 105(h) Testing Apply?

This is where most guidance on ICHRA nondiscrimination gets it wrong, or simply stays silent. Section 105(h) imposes two tests on self-insured health plans: an eligibility test (who can participate) and a benefits test (what benefits are available). Both are designed to catch plans that disproportionately favor HCIs.

But here’s the critical distinction that almost no competitor page states clearly:

An ICHRA that only reimburses insurance premiums is treated as an insured plan and is not subject to Section 105(h) nondiscrimination testing.

This means if your ICHRA reimburses only the cost of individual health insurance premiums (not out-of-pocket medical expenses like copays, prescriptions, or other Section 213(d) expenses), you skip the 105(h) eligibility and benefits tests entirely. For many employers, this is a major compliance simplification.

On the other hand, an ICHRA that also reimburses qualifying medical expenses beyond premiums remains subject to full 105(h) testing.

Two IRS Safe Harbors

The IRS Final Rule established two safe harbors for ICHRA plan design:

1. Allowance variation safe harbor. The maximum dollar amount can vary within or between classes without violating the uniform contribution requirement, as long as within-class variations only reflect age or family size, and each class is a permitted class under the ICHRA rules.

2. Age-variation safe harbor. An ICHRA that satisfies the age-variation exception (the 3:1 ratio) will not automatically fail the nondiscriminatory benefit test solely because of age-based differences.

The Operational Nondiscrimination Trap

Meeting the safe harbors on paper is necessary but not sufficient. The IRS cautions that satisfying the design safe harbors does not guarantee operational nondiscrimination. If a disproportionate number of highly compensated individuals qualify for and actually use the maximum age-based allowance, the ICHRA can still be found discriminatory in operation.

Practitioners on Reddit and benefits forums frequently overlook this nuance. The safe harbor protects the plan design. It does not protect the plan’s actual utilization patterns. Employers with a concentration of older, highly compensated employees receiving the maximum age-adjusted allowance should monitor participation data annually.

The 11 Permitted ICHRA Employee Classes

The IRS recognizes 11 distinct classifications employers can use to group employees for ICHRA purposes. Different classes can receive different allowance amounts, which is the primary mechanism for structuring ICHRA allowances to comply with nondiscrimination rules while still tailoring benefits to workforce segments.

Key Rules for Using Classes

One class per employee. Each employee can belong to only one class at a time. You cannot place someone in both the “full-time” and “salaried” classes simultaneously.

Combination classes are valid. You can create a class like “full-time salaried employees in California,” combining employment status, compensation type, and geography.

Classes organize labor categories, not risk pools. Unlike traditional group plan classes, ICHRA classes align with how you organize your workforce. They are not designed to group employees by health status or expected utilization.

For a step-by-step walkthrough of calculating employee classes by role, see our dedicated guide.

Age-Based Allowance Variation: The 3:1 Ratio Explained

The age-based variation is the most common tool employers use to customize ICHRA allowances within a class. Because individual market premiums increase with age (up to a 3:1 ratio under ACA rules), the ICHRA rules mirror that same ratio.

How It Works

If the youngest employee in a class receives $300 per month, the oldest employee in that same class can receive up to $900 per month. Any amount between $300 and $900 is permissible, as long as the 3:1 ceiling holds.

Worked example:

One-Year Banding vs. Bracket Banding

Employers have two approaches to age-based variation:

One-year age banding assigns a unique allowance amount to each age. A benefits consultant writing on LinkedIn recommends this as the “most complex but most equitable” approach, because it tracks actual premium differences year by year.

Bracket banding groups ages into ranges (e.g., 25-34, 35-44, 45-54, 55-64) and assigns a single allowance to each bracket. Simpler to administer, but less precise.

Practical tip: Work backward from the amount you want to offer your oldest employees. Divide by three to find the minimum you must offer the youngest. This ensures you don’t accidentally exceed the ratio.

Family Size Variation

Employers can offer larger allowances to employees who enroll dependents in individual health coverage. A single employee might receive $400 per month, while an employee covering a spouse and two children receives $800.

The rule is straightforward: family size variation must apply consistently to all employees within the class. You cannot offer a family-size bump to some employees and not others in the same class.

Family size and age variations can be combined. An older employee with dependents could receive both a higher age-adjusted amount and a family-size increase, creating meaningful differentiation within a single class while remaining fully compliant.

For guidance on handling partial reimbursements when family coverage costs vary, see our HRA guide.

Minimum Class Size Rules

Minimum class size requirements are one of the most misunderstood aspects of ICHRA compliance. They only apply in one specific scenario: when an employer offers both a traditional group health plan and an ICHRA to different employee classes simultaneously.

When Minimums Apply

If you offer group coverage to full-time employees and an ICHRA to part-time employees, the ICHRA classes are subject to minimum size thresholds:

These minimums apply specifically to full-time, part-time, salaried, hourly, and sub-state geographic classes.

When Minimums Don’t Apply

If you only offer an ICHRA (no group plan running alongside it), minimum class size rules do not apply. This is a significant relief for small employers. An employer with 5 full-time and 3 part-time employees can create two ICHRA classes with different allowances and face no minimum size requirement.

Employers considering a switch from group health to ICHRA should note that eliminating the group plan entirely also eliminates these minimums.

ACA Affordability for Applicable Large Employers

Employers with 50 or more full-time equivalent employees (ALEs) face an additional layer of compliance: the ICHRA must satisfy the ACA’s affordability standard, or the employer risks penalties under the employer shared responsibility provisions.

The 2026 Affordability Threshold

For the 2026 plan year, an ICHRA offer is considered affordable if the employee’s share of the lowest-cost silver plan premium in their area, after subtracting the employer’s ICHRA contribution, does not exceed 9.96% of their household income.

The IRS provides three safe harbor methods to determine affordability without requiring access to actual household income data:

1. W-2 wages safe harbor. Uses the employee’s W-2 Box 1 wages.
2. Rate of pay safe harbor. Uses the employee’s hourly rate multiplied by 130 hours per month.
3. Federal poverty line (FPL) safe harbor. Uses the mainland FPL for a single individual.

For a detailed walkthrough of each method, see our 2026 ICHRA affordability guide.

What Happens If the ICHRA Fails Affordability

Failing the affordability test does not void the ICHRA. Employees still have a valid HRA. But the employer faces penalties:

• Section 4980H(b) penalty: $5,010 per year for each full-time employee who declines the unaffordable ICHRA offer and instead receives a premium tax credit on the marketplace.
• Section 4980H(a) penalty: $3,340 per year per full-time employee (minus 30) if the employer fails to offer coverage to at least 95% of full-time employees.

These are 2026 figures, and they add up fast. An ALE with 100 full-time employees where 20 decline an unaffordable ICHRA and claim premium tax credits would face $100,200 in 4980H(b) penalties alone.

For the full breakdown, read our ACA employer penalty guide.

HSA-Compatible ICHRA Flexibility

One nuance that rarely appears in compliance guides: the ICHRA Final Rule allows employers to offer both an HSA-compatible ICHRA and a non-HSA-compatible ICHRA within the same employee class. Employees can choose which version they want.

This matters because employees enrolled in a high-deductible health plan (HDHP) may want to maintain HSA eligibility. An HSA-compatible ICHRA only reimburses premiums, preventive care, or expenses after the HDHP deductible is met. Giving employees the choice within a single class satisfies nondiscrimination rules because both options are available to everyone on the same terms.

ERISA Documentation and Notice Requirements

Compliance with nondiscrimination rules is not just about getting the allowance math right. Two administrative requirements trip up employers more often than the substantive rules.

Formal Plan Document

Every ICHRA must be established through a written plan document under ERISA. This document specifies eligible classes, monthly allowance amounts, the plan year, mid-year change rules, and termination procedures. Operating an ICHRA without a proper plan document, or with a document that doesn’t match your actual practices, creates compliance risk that no allowance structure can fix.

90-Day Advance Notice

A written notice must be provided to every eligible employee at least 90 days before the start of the plan year. For a January 1 plan year, that means delivery no later than early October. The notice must explain the ICHRA terms, the employee’s right to opt out, and the impact on premium tax credit eligibility.

Missing the 90-day deadline doesn’t automatically invalidate the ICHRA, but it undermines the employee’s ability to make an informed decision and creates a documentation gap that regulators notice.

Common Mistakes to Avoid

Structuring ICHRA allowances to comply with nondiscrimination rules requires attention to several frequent pitfalls:

Varying allowances within a class for unauthorized reasons. Giving a manager $600 and a coordinator $400 in the same “full-time salaried” class because one has more responsibility is a violation. The only within-class variations permitted are age and family size.

Exceeding the 3:1 age ratio. If your youngest employee gets $250 and your oldest gets $800, you’re fine (3.2x would not be). But if the youngest gets $250 and the oldest gets $900, you’ve hit 3.6x and violated the cap. Always double-check the math.

Offering employees a choice between ICHRA and group coverage in the same class. You cannot let some employees in a class choose the group plan while others choose the ICHRA. ICHRA and group coverage must be offered to distinct classes.

Basing allowances on individual premium costs. Reimbursing employees based on what their specific plan costs creates unequal treatment within the class, even if the employer’s intent is fairness.

Skipping the plan document or the 90-day notice. Both are legally required. Many first-time ICHRA employers focus on allowance amounts and forget the paperwork.

Ignoring operational nondiscrimination. Even with a perfectly designed plan, if HCIs disproportionately receive the maximum age-adjusted allowance, the IRS may determine the plan is discriminatory in practice.

Compliance Checklist: Quick Reference

Use this checklist before finalizing your ICHRA allowances for any plan year:

• [ ] Define employee classes using only the 11 IRS-permitted categories
• [ ] Confirm each employee belongs to exactly one class
• [ ] Set a uniform allowance for all employees within each class
• [ ] If varying by age, verify the 3:1 ratio holds for every class
• [ ] If varying by family size, apply the variation consistently within each class
• [ ] If offering both group coverage and ICHRA, verify minimum class size thresholds
• [ ] If an ALE, run the affordability calculation using an IRS safe harbor
• [ ] Determine whether the ICHRA reimburses only premiums (exempt from 105(h)) or also medical expenses (subject to 105(h))
• [ ] Draft or update the formal ERISA plan document
• [ ] Deliver the written employee notice at least 90 days before the plan year starts
• [ ] Review participation data to assess operational nondiscrimination risk
• [ ] Document everything for audit readiness

Explore how SimplyHRA works to see how automated class configuration and compliance tracking support each step of this checklist.

Frequently Asked Questions

Can I give executives a higher ICHRA allowance than other employees?

Only if executives are in a different employee class. Within the same class, every employee must receive the same allowance (with permitted age and family size adjustments). You could, for example, create a “salaried” class and an “hourly” class with different allowance amounts. But you cannot single out executives within a class that also includes non-executive employees.

Do nondiscrimination rules apply if I only reimburse premiums?

The ICHRA “same terms” requirement and class-based rules always apply. However, a premiums-only ICHRA is exempt from Section 105(h) nondiscrimination testing because it is treated as an insured plan. This is a significant simplification that many employers overlook.

What happens if my ICHRA fails nondiscrimination testing?

For a premiums-only ICHRA, 105(h) testing doesn’t apply, so there’s nothing to fail on that front. For an ICHRA that reimburses medical expenses, a 105(h) failure means the excess reimbursements to HCIs become taxable income. Separately, if an ALE’s ICHRA fails the ACA affordability standard, the employer faces penalties of $5,010 per affected employee per year under Section 4980H(b) for the 2026 plan year.

Does a small employer with fewer than 50 employees need to worry about ACA affordability?

No. The ACA employer mandate only applies to applicable large employers with 50 or more full-time equivalent employees. Small employers still must follow the ICHRA same-terms requirement, class rules, documentation requirements, and the 90-day notice, but ACA affordability testing and penalties do not apply.

Can I combine two employee classes into one?

Yes. The IRS permits combination classes, such as “full-time employees in Texas” or “part-time seasonal employees.” The combination must use only the 11 recognized categories. The same-terms requirement applies within the resulting combined class.

Do minimum class size rules apply if I only offer an ICHRA?

No. Minimum class size thresholds only kick in when an employer offers both a traditional group health plan and an ICHRA to different employee classes. If the ICHRA is your sole health benefit, there are no minimum class size requirements.

Can employees in the same class choose between an HSA-compatible and non-HSA-compatible ICHRA?

Yes. The Final Rule allows employers to offer both an HSA-compatible and a non-HSA-compatible ICHRA within the same class, letting employees choose. This does not violate the same-terms requirement because both options are available to all class members equally.

Structuring ICHRA allowances compliantly is not complicated once you understand the framework: define permitted classes, apply uniform allowances within each class, stay within the 3:1 age ratio, and handle documentation properly. The rules reward thoughtful planning and penalize improvisation.

If you’re setting up your first ICHRA or restructuring an existing one, schedule a consultation to get personalized guidance on class design, allowance amounts, and affordability compliance for your workforce.