Defined contribution health plans represent a new way of doing employee benefits. Defined contribution strategy rests on the many advantages of the Qualified Small Employer HRA (QSEHRA) for small business owners and the Individual Coverage HRA (ICHRA) for businesses of all sizes. Our favorite part? Freedom. The freedom to choose a contribution amount that works for your budget, and the freedom to customize the design to help your bottom line.
But in the midst of all of this freedom, there's a few rules you need to know about when designing your HRA. We’d like to lay out the options here, in one place, so that you can see them in a concise and simple way.
A defined contribution health plan, also referred to is defined contribution insurance, is an arrangement between employer and employee that allows employers to set aside dollars each month to contribute toward employee's individual health insurance plans. These contributions are pre-tax and not subject to employer tax or payroll tax. Employees then sign up for the individual health plan that meets their needs. The result is cost control and risk de-management for the employer and flexibility for the employees.
Let's start by explaining why defined contribution health plans work so well for businesses trying to control health benefits spending. While you, as a small business owner, can choose who to extend QSEHRA reimbursements to, you must make sure your extensions are chosen fairly and without discrimination. For example, you cannot pay 50% of your employees' premiums and 100% of premiums for managers.
An overarching rule of defined contribution strategy is that all full-time employees must be treated fairly, as the IRS outlines in “same terms requirements.” What you can do, however, is use small business HRA design criteria to divide your employees into groups. Once you do that, you can decide what amount to extend to each group.
Defined contribution health plans have become popular as employers and employees seek more flexible, cost-effective healthcare solutions. These plans offer distinct advantages to each group, fostering a more personalized approach to health benefits.
Employers seeking a cost-effective, flexible approach to offering health benefits will find defined contribution health plans an attractive solution. These plans simplify budgeting and administration and offer tax advantages and the ability to tailor benefits to meet organizational and employee needs.
One of the primary advantages for employers is the predictability of costs associated with defined contribution health plans. Employers allocate a fixed amount for each employee's healthcare benefits. This fixed liability helps in budgeting and financial planning, as the company's healthcare costs are known in advance and do not fluctuate based on actual healthcare usage.
Employers have the flexibility to design the contribution plan to align with their budget and employee needs. This means they can decide on the contribution amount and whether to offer additional options or benefits. Such flexibility allows for a more tailored benefits package that can be used as a tool for recruitment and retention.
Defined contribution plans are generally easier and less time-consuming to administer than traditional health benefits plans. Employers can set up their contribution, and then the employees are responsible for selecting and managing their own insurance. This reduces the administrative burden on the company’s HR department.
For some employers, defined contribution health plans can be structured as self-funded plans. This approach can provide additional savings and tax advantages because employers can bypass certain insurance taxes and profit margins charged by insurance carriers.
Employers can offer defined contribution health plans on a pre-tax basis, which means the contributions are not subject to payroll taxes. This provides a tax-efficient way to offer health benefits to employees.
For employees, defined contribution health plans represent an opportunity for greater autonomy and customization of their healthcare coverage. These plans offer the benefits of lower monthly premiums, a wider range of choices, and coverage portability, empowering individuals to make decisions that best suit their health and financial circumstances.
Employees often experience lower monthly premiums with defined contribution health plans. Since they can choose the plan that best fits their needs and budget, they can select more cost-effective options that traditional employer-provided plans might not offer.
Defined contribution health plans allow employees to choose their health insurance provider and plan. This increased choice empowers employees to select plans that best meet their personal and family healthcare needs, preferences, and financial situations.
A significant benefit for employees is the portability of defined contribution health plans. Unlike traditional employer-sponsored health insurance, which typically ends when an employee leaves the company, the defined contribution allows for greater continuity of care. Employees can take their health plan with them if they change jobs, ensuring they do not experience a gap in coverage.
Defined contribution health plans offer flexible, cost-effective options for both employers and employees. Two popular choices are Health Reimbursement Arrangements (HRAs) and Health Savings Accounts (HSAs). Understanding the differences and benefits of HRAs and HSAs is crucial for making informed decisions about healthcare benefits.
Health Savings Accounts (HSAs) are tax-advantaged accounts designed for individuals with high-deductible health plans (HDHPs) to save for medical expenses. HSAs offer triple tax benefits: contributions are tax-deductible, the account grows tax-free, and withdrawals for qualified medical expenses are not taxed. HSAs are owned by the individual, making them portable across jobs, and funds roll over from year to year, encouraging savings for future healthcare needs.
Health Reimbursement Arrangements (HRAs) are employer-funded group health plans from which employees are reimbursed tax-free for qualified medical expenses up to a fixed dollar amount per year. Unlike HSAs, HRAs are solely funded by the employer, and unused amounts may be rolled over to the next year at the employer's discretion. HRAs offer flexibility in plan design, allowing employers to control costs while providing valuable benefits to employees.
In addition to traditional HRAs and HSAs, two relatively new health reimbursement arrangements—Individual Coverage Health Reimbursement Arrangements (ICHRAs) and Qualified Small Employer Health Reimbursement Arrangements (QSEHRAs)—offer enhanced flexibility and benefits for both employers and employees. These options cater to the diverse needs of the modern workforce and the varying capabilities of employers to provide health benefits.
The Individual Coverage Health Reimbursement Arrangement (ICHRA) allows employers of any size to reimburse employees tax-free for their health insurance premiums and, in some cases, medical expenses. This arrangement provides great flexibility, as employers can set their reimbursement rates while employees can choose their health insurance plan. ICHRAs are particularly beneficial for companies looking for a scalable, budget-friendly way to offer health benefits without the complexity of managing a traditional group health insurance plan.
Qualified Small Employer Health Reimbursement Arrangements (QSEHRAs) are designed specifically for small businesses with fewer than 50 employees that do not offer a group health insurance plan. Through a QSEHRA, small employers can reimburse their employees for premiums and medical expenses up to a maximum limit set annually by the IRS. This arrangement offers small businesses a practical way to provide health benefits by leveraging the individual insurance market, thereby avoiding the high costs and complexities associated with group health plans.
ICHRA and QSEHRA arrangements provide tax advantages and the flexibility to tailor health benefits to the workforce's needs, making them appealing options for employers and employees navigating the evolving healthcare benefits landscape.
Let's review the basics of using defined contribution insurance to customize your benefits offerings. Here are a few HRA rules to keep in mind.
Come one, come all: One of the most straightforward options is to reimburse each employee the same amount.
For example, all employees receive $250 monthly regardless of age, family size, status, etc.
Max it out: Another simple option is to reimburse each employee the maximum amount. This amount would change slightly each year.
For example, in 2020, all single employees would get $437.50 per month and all employees with dependents would get $883.33 per month.
Family size: Like the option listed above, you can reimburse different amounts based on family size and set different rates based on an employee’s dependents. The IRS requires that employers choose a reference plan or offer a fair percentage of the maximum.
For example, single employees get $200 each month, married employees get $300 each month, and employees with families get $400 each month.
Age: The last option we have for you would be to reimburse different amounts based on an employee’s age. This might not seem fair, but it's an unspoken truth that older employees need access to healthcare more often than the young and healthy. Employers can vary rates by age, but they must be tied to a reference plan on the individual market. To help figure out this model, most marketplace plans offer premiums in a 1:3 ratio for individuals ages 26 to 64.
For example, you could use the 1:3 ratio to set reimbursement rates for a 26-year-old of $100 per month and a 64-year-old of $300 per month. A 37-year-old employee gets whatever amount is on the linear line between the 26-year-old and 64-year-old. In this case, it's $158 each month.
As an employer, you can decide whether or not to extend QSEHRA benefits to the following groups:
Defined contribution health plans have emerged as a popular alternative to traditional employer-provided health insurance, offering flexibility, personalization, and potential cost savings. Below are some frequently asked questions that help clarify common inquiries about this approach to health benefits.
The primary difference between a defined contribution approach and traditional benefits lies in the allocation of funding and choice of insurance plans. In a traditional benefits scheme, the employer selects one or more group health insurance plans to offer employees, often covering a significant portion of the premiums. With a defined contribution approach, employers allocate a fixed amount of money to each employee, who can use these funds to purchase their own insurance on the marketplace. This shift offers more choice and autonomy to the employee while providing cost predictability and reduced administrative burdens for the employer.
The minimum or maximum contribution limits for defined contribution plans can vary depending on the specific type of plan (e.g., HRA, ICHRA, QSEHRA) and current regulations. For HRAs, including ICHRAs and QSEHRAs, the IRS sets forth specific guidelines that may change annually. Generally, there's no minimum contribution requirement, but there are maximum limits, especially for QSEHRAs. Employers are encouraged to consult current IRS guidelines or a benefits advisor to ensure compliance with contribution limits.
Employers can give employees different amounts with defined contribution plans, especially with ICHRAs. Employers can vary contribution amounts based on employees' age, family size, or other defined criteria. This flexibility allows employers to tailor their benefits offering to match the diverse needs of their workforce better. However, adhering to nondiscrimination rules and regulations is important to ensure fairness and compliance.
In a defined contribution health plan, the "options" typically refer to the amount of funding provided to employees or the choice among different reimbursement arrangements (e.g., HRAs, HSAs). Technically, there's no limit to how many different contribution levels or arrangements an employer can offer as long as they comply with regulatory guidelines and nondiscrimination laws. However, offering too many options can confuse employees and complicate the administration. Employers often seek a balance by categorizing employees into groups based on fair criteria (like job classification, full-time vs. part-time status, or family size) and then offering tailored options to each group.
For HSAs, any unused funds roll over to the next year, allowing employees to build a savings account for future medical expenses. In the case of HRAs, including ICHRAs and QSEHRAs, whether unused funds can be rolled over depends on the plan's structure as defined by the employer. Some HRAs allow unused amounts to roll over into the next year, increasing the subsequent year's reimbursement limit, while others may not.
Defined contribution funds, particularly in HRAs and HSAs, are intended for healthcare expenses. Withdrawals from HSAs for non-qualified expenses are subject to taxes and penalties if the account holder is under 65. Similarly, reimbursements from HRAs are strictly for qualified medical expenses. Using these funds for other purposes can lead to tax implications and is generally not allowed.
Contributions to HSAs are tax-deductible, and distributions used for qualified medical expenses are tax-free. For HRAs, including ICHRAs and QSEHRAs, employee reimbursements for qualified healthcare expenses are not included in taxable income, offering a tax advantage. The specifics can vary, so employees must consult a tax advisor for personal tax implications.
Eligibility for defined contribution plans like ICHRAs and QSEHRAs can vary based on the plan's design and the employer's criteria. Generally, employers can set eligibility criteria for these plans, but they must comply with regulations to ensure fairness. For example, with ICHRAs, employers can define eligibility based on job classifications, but they cannot discriminate based on health conditions.
Employees participating in an HRA (like an ICHRA) or benefiting from a QSEHRA may have their eligibility for premium tax credits affected. If the HRA or QSEHRA provides affordable coverage that meets minimum value standards, the employee may not be eligible for premium tax credits on the Health Insurance Marketplace. However, specifics can vary, and employees may need to consult with a benefits advisor or use tools provided by the Health Insurance Marketplace to determine their eligibility.
If you want to set up a small business HRA, Take Command’s small business platform can help. We’ll take care of all the accounting and legal legwork, handle each employee's onboarding, and make tax time easy and painless. You’ll never have to worry about the hassle of receipts or choosing a health plan again. Trust us, it’s easier than you think.
Hungry for more? The reimbursement rules chapter in our QSEHRA guide is a great place to start.