You can use fail through on a server group whether you are terminating on the controller or not; it works either way. It is typically not enabled when the two servers are from the same directory source; for example two RADIUS servers point to the same AD. But if you have two differing sources of users, then fail through can be enabled regardless of the termination setting.
In your example, the authentication attempt will be tried against the RADIUS server (1).....that request will fail as that user doesn't exist (assuming they don't exist)....it will then try the Internal DB.