Health Reimbursement Arrangement (HRA) – What is it?
Section 105 health reimbursement plans are more commonly known as Health Reimbursement Arrangements or (HRA’s). A Health Reimbursement Arrangement or HRA, is an IRS approved, employer-funded, tax advantaged employer health benefit plan that reimburses employees for out of pocket medical expenses including individual health insurance premiums. A health reimbursement arrangement is not health insurance but allows the employer to make contributions to an employee’s account and provide reimbursement for eligible expenses.
Many businesses use these plans as their sole employer-sponsored health coverage. A business might also use a Section 105 health reimbursement plan as a supplement to traditional employer health insurance to reimburse deductibles, dental or vision and pay for a wide range of medical expenses not covered by insurance.
Section 105 of the IRS code allows small business owners to setup Health Reimbursement Plans (HRPs) to pay for healthcare expenses tax-free. With a Section 105 health reimbursement plan, an employer can reimburse an employee for healthcare and insurance expenses. These can be expenses incurred by the employee or his or her dependents, but they must be allowed under the plan document, which is created by the employer and outlines the expenses eligible for reimbursement.
Health Reimbursement Arrangement Administration Reporting Features – make real-time monitoring of health reimbursement arrangement liabilities, reimbursements and utilization easy. Employers can change plan benefits at any time or cancel the entire plan at any time. Further, health reimbursement arrangements allow employers to establish plan-year maximum reimbursements for any given category of expense (e.g., dental) and to establish a maximum balance that any participant class may hold at a time. (Participant class is defined by the employer).
Advantages of Section 105 Health Reimbursement Plans
Employees are given greater control over the health plan they choose, and the money used to reimburse them is not considered taxable income. Hence, employees can save 20-40% on health insurance when compared to paying with post-tax dollars, depending on how much he or she pays in taxes.
In the same vein, employers deduct reimbursements as a business expense and exclude them from wages subject to FUTA (0.8%) and the employer portion of FICA (7.65%). Employers have enormous flexibility and control in regard to establishing maximum reimbursement amounts and setting eligibility requirements via the plan document.
Health reimbursement arrangements are notional arrangements – no funds are expensed until reimbursements are paid. Employers reimburse employees directly only after the employees incur approved medical expenses. Unlike a Health Savings Account (HSA), there is no limit to the amount of money an employer can contribute to an employee’s health reimbursement arrangement.
A health reimbursement arrangement may reimburse any expense considered to be a qualified medical expense under IRS Section 213 of the Code, including premiums for personal health insurance policies. Within IRS guidelines, employers may restrict the list of reimbursable expenses in any way they choose.
Health reimbursement arrangement balances may roll forward from year to year. Employers can design the program not to allow balances to rollover from one year to the next. However, limiting the rollover feature defeats a key health reimbursement arrangement advantage. Employers may allow employees to have access to their health reimbursement arrangement accounts after retirement. However, employers may not pay/distribute cash or other benefit balance to any employee.
How to set up a Section 105 Health Reimbursement Plan
Section 105 health reimbursement plans are actually quite simple in practice: The employer must establish a formal written Section 105 health reimbursement plan.
HRA Plan Documents must comply with IRS and ERISA rules
Since an HRA is subject to ERISA, a legal HRA plan document must be provided in writing. A Summary of Benefits is not considered an HRA Plan Document or HRA Summary Plan Description (SPD). If an HRA exists without a written HRA Plan Document—it is out of compliance.
An HRA Plan Document should contain the following:
1. Name of the HRA Plan Document Administrator
2. Designation of any Named Fiduciaries other than the HRA Plan Administrator under the claims procedure for deciding benefit appeals
3. A description of the HRA benefits provided
4. The standard of review for HRA benefit decisions
5. Eligibility criteria (e.g., classes of employees, waiting period for new hires, and hours worked per week)
6. The effective date of participation (e.g., next day or first of month following satisfaction of the HRA Plan Document eligibility waiting period)
7. Amount the HRA Participant must pay towards the cost of HRA coverage (typically $0)
8. HRA Plan Sponsor’s amendment and termination rights and procedures, and what happens to HRA Plan assets, if any, in the event of HRA Plan termination
9. Rules restricting and regulating the use of Protected Health Information (PHI), if Plan Sponsor uses PHI
10. Coordination of Benefits provisions
11. Procedures for allocating and designating administrative duties to an HRA TPA or committee
12. How the HRA plan is funded
13. Information regarding COBRA, HIPAA, and other federal mandates
14. The employer determines the amounts available to each employee for reimbursements during a period of coverage (generally a year).
15. As eligible expenses are submitted, the employer reimburses the employees (100% tax-free) up to the available amounts.
16. Unused funds at the end of the year are typically carried over to the next year, but the employer can set those stipulations.
Administering a Section 105 Health Reimbursement Plan
Can a business self-administer a Section 105 health reimbursement plan? The short answer is yes, but it is virtually impossible for a business to stay in compliance without proper administrative software. A primary reason for using compliant administrative software is that many employers will otherwise overlook important compliance obligations that put them at risk financially. Failure to comply with the following requirements can cost an employer thousands of dollars per day in fines:
- HIPAA Privacy
- IRS Rules
- ERISA Rules
- Medicare Reporting
- Legal Plan Documents
- COBRA (if applicable)
- New Affordable Care Act (ACA) Requirements
The top three reasons employers should consider using HRA Software to self-adminster an HRA:
- Tax Savings/IRS Compliance
- Federal Compliance
HRA Admin Software Creates Tax Savings
If an employer pays for employee’s individual health insurance premiums without utilizing HRA admin software, such payments might need to be reported as taxable income to the employees.
Employees receive dollars 100% tax-free
The IRS requires that HRA Plan Documents be established in order for employees to deduct the individual health insurance premiums from taxable income on their annual W-2.
HRA Admin Software (and their tax benefits) increase the ability of employers to recruit and retain good employees.
Employers deduct reimbursements as non-taxable business expense
An IRS-compliant defined contribution health plan will ensure the tax deductibility of employee’s individual health insurance premiums.
The federal government has guidelines for employers who want to contribute to employee’s IRS-qualified medical expenses. An IRS/ERISA/HIPAA-compliant defined contribution health plan will ensure compliance with federal law.
Using HRA software, employees submit claims for health insurance premiums and other medical expenses online, via fax, or mail. Once submitted, claims are processed and employers click a button periodically to reimburse employees via check, payroll addition, or direct deposit; all reimbursements go directly from the employer to the employee at the time and method chosen by the employer. All claims are kept HIPAA-protected and all receipts are stored digitally in compliance with HIPAA required by the IRS for company and personal audit purposes.
Some companies might want to pay directly for an employee’s individual health insurance plan without utilizing an ERISA and HIPAA-compliant defined contribution health plan, but doing so will put the employer out of compliance with federal regulations and increase the employer’s (and employee’s) tax liability.
There are two major reasons an employer should never pay for its employee’s individual health insurance plan:
When an employer pays directly for an individual health insurance plan, they effectively endorse each employee’s individual insurance plan as part of an employer-sponsored group health benefit offering. In other words, according to federal law, the employer is treating the individual plan as part of an employee welfare benefit plan regulated by ERISA. Because most individual health insurance plans do not meet minimum ERISA group plan requirements, the employer is out of compliance.
Separately, an employer is not allowed to know the details of employees HIPAA-protected medical expenses. Because most individual health insurance costs are based on an employee’s health, the health insurance details must be HIPAA protected. When an employer pays for the individual policy, they can violate HIPAA-privacy requirements because they know the details of a HIPAA-protected employee expense.
3. Ease of Use
HRA Administration software allows an employer to administer the benefits program in less than 5-minutes per month! The process is completely online and paperless.
Pre-taxing occurs via payroll
HRA administration software does not require a Third Party Administrator (TPA) to touch the employer’s money. All reimbursements go directly from the employer to the employee at the time and method chosen by the employer (typically via payroll).
There are many additional benefits of using an administrator versus self-administration, such as online claim submission and processing, integrated plan documents, and different allowances by class of employee.
Similar Plans to Section 105
There are many different terms that are synonymous with Section 105 health reimbursement plans. Some common terms you might hear are:
- Health Reimbursement Arrangement
- Health Reimbursement Account
- Health Reimbursement Plan
- Medical Expense Reimbursement Plan
- Medical Reimbursement Plan
- Section 105 Plan
Health Reimbursement Arrangements FAQs
One of the most important considerations for employers as they prepare to transition to a defined contribution plan is the design of the underlying health reimbursement arrangement (HRA).
Here is a guide with answers to some frequently asked questions (FAQs) on HRAs.
What is the difference between a Health Reimbursement Arrangement and an HSA or FSA?
An HRA, HSA and FSA are all IRS-approved plans where distributions are used to pay for qualified medical expenses on a pre-tax basis. However, there are some key differences:
- HRA: An HRA is a notional account funded solely by the employer. Employees may not contribute. Contributions are not included in employees’ income. Employers pay only after their employees incur eligible medical expenses. An HRA is the only IRS-approved plan that allows an employer to reimburse for individual health insurance policies.
- HSA: An HSA is a financial account and can be funded by the employer and/or the employee, as well as any other person (such as a family member). Contributions, other than employer contributions, are deductible on the eligible individual’s tax return whether or not the individual itemizes deductions. Employer contributions are not included in income.
- FSA: An FSA can be funded by the employer and/or the employee, though usually it is funded primarily by the employee.
Why would an employer offer a Health Reimbursement Arrangement?
An HRA allows companies to offer flexible benefits, providing an alternative for companies who cannot offer group health insurance due to high cost or participation requirements.
HRAs offer certain advantages for employers:
- HRA funds are controlled and retained by the employer upon termination of the employee. There are no minimum or maximum HRA contribution amounts, and no minimum HRA participation requirements.
- HRA funds can accumulate from year to year, offering a retention incentive.
- HRAs offer flexibility in health benefit plan design. Employers determine how they want to use the HRA, either as the entire health benefit for the company, or as a supplement to a group health plan.
How many Health Reimbursement Arrangements have been established?
While the total number of HRAs is not available as a single number, according to the IRS the total number of HRAs and HSAs combined in 2010 was 5.7 million, up from 1.2 million in 2006.
Advantages of an HRA?
HRAs give employers and individuals more control over medical expenses.
- HRA funds are used only for IRS-qualified health insurance premiums and medical expenses and encourages consumer-directed health care spending.
- HRAs do not require either the employer or the individual to set up a separate bank account. Reimbursements are issued directly to the employee.
- HRA reimbursements are tax-deductible for the employer and tax-free for the employee.
- HRAs allow employers to control and predict the maximum expense related to health care benefits for their employees.
- A majority of employers allow HRA rollover, which lets employees accrue (save) their HRA balance from year to year, contributing to employee retention.
- Individuals can use auto-reimbursement of premiums to simplify management of their HRA funds.
How do HRAs work?
Employers choose the amount of HRA allowances to provide to employees (monthly or annual allowances). These funds are notional, and available to reimburse individuals for health care expenses including health insurance premiums. Individuals can be reimbursed with HRA funds for premiums with any insurance plan, as well as other qualified medical expenses.
What are critical underwriting or participation requirements?
With an HRA, there is no underwriting and no participation requirements. HRA Administration fees are typically based on the size of the company and plan participation.
The HRA plan must meet basic IRC Section 105 non-discrimination requirements to obtain favorable tax treatment. Benefits may be tiered according to single vs. family coverage, or based on bona-fide job criteria such as years of service, location, job description, or employee status (active vs. retired).
What do employers need to think about when setting up an HRA?
A good HRA Administrator gives employers a great deal of flexibility in determining HRA design.
Employers have control and choice over:
- Eligibility Requirements
- Plan Design (contribution levels, reimbursable expenses, rollover/accumulation options)
- Reimbursement Schedule
- Reimbursement Methods
How much do HRAs cost and what are typical funding levels?
The cost of an HRA is entirely set by the employer. Important factors include:
- The amount of employees’ HRA allowances
- How much of the allowance (if any) will be rolled over year-to-year
HRA funding levels vary widely with no minimum or maximum amounts.
Is rollover of unused HRA funds required?
No. Employers determine whether or not employees’ unused HRA balance carries over from year to year. Rollover amounts may be unlimited, capped at pre-determined annual amount, or set at no-rollover.
Are there minimum and maximum amounts of funding for HRA plans?
Currently there are no annual minimum or maximum limits on HRA plan funding.
What medical expenses can HRA funds be used for?
IRC Section 213(d) sets which medical expenses are reimbursable through an HRA. Within this list, employers can restrict categories of expenses. Most employers allow all qualified 213(d) expenses to be eligible for reimbursement, including but not limited to the following:
- Individual Health Insurance Premiums
- Hospital Services
- Doctor Visits
- Psychologist / Mental Health
- Chiropractic Services
- Eye Exams
- Birth Control
- Hearing Aids
- Home Care
- Lab Fees
- Nursing Services
What Medical, Dental and Prescription Expenses are Eligible for Reimbursement Under an HRA?
Health Reimbursement Arrangements (HRAs) allow employers to reimburse employees for eligible medical and insurance expenses tax-free.
It’s important to note that each businesses’ HRA is different. Employers can choose to customize their HRA with different monthly allowances, varying allowances by class of employee, and specific reimbursable and non-reimbursable expenses.
Can employees have an HRA and an HSA or FSA?
Yes. All three programs can exist alongside one another, but employers must be careful about how they work together. For example, with both an HSA and FSA there are special ordering (“coordination”) rules to consider.
The difference between HRAs and HSAs
There are a lot of acronyms used when discussing non-traditional health benefits options. Two of the most popular and promising options are HSAs (Health Savings Accounts) and HRAs (Health Reimbursement Arrangements). Even though they both have the same basic idea, there are a few key differences. If you have an HSA/HRA or you are considering offering one to your employees, consider the following:
HRAs vs HSAs: HRAs are owned by the employer, HSAs are owned by the individual
HRAs are employer sponsored plans. An employer sets allowances for employees who can then use that money to be reimbursed for medical expenses. HSAs are individual accounts that employers sometimes choose to contribute to. While HSAs are often packages as “employer benefits”, they are really more like IRAs in that individuals can set them up and contribute to them on their own.
HRAs vs HSAs: HSAs are actual accounts
When money is put into an HSA, it belongs to the account holder. If an employer contributes to an employee’s HSA, the employee controls that money immediately, even if they leave the company.
When money is added to an HRA, it still belongs to the employer until an actual medical expense is incurred. If an employee leaves a company without spending all the money in the HRA, they lose access to that money.
HRAs vs HSAs: HSAs don’t cover health insurance premiums
HRAs are designed to act as full health benefits solutions so that employers can pay all or some of the medical expenses of employees. HSAs are meant to cover expenses that fall under the deductible of a health insurance plan. As such, HSA money generally can’t be used to pay for the insurance itself.
While we’re on the topic, an employer can choose exactly which medical expenses an HRA will cover. If a company wants to cover insurance and pharmacy, but not dental or maternity, the HRA can handle that. Because HSAs are owned by the individual, the employer doesn’t have anything to do with what can be reimbursed.
HRAs vs HSAs: HSAs require compatible plans
In order to contribute to an HSA, an individual must have a high-deductible plan. High deductible plans make a lot of sense for most Americans, so this isn’t a problem, but keep in mind that HRAs don’t have that restriction.
HRAs vs HSAs: The Bottom Line
HSAs and HRAs are both really great products. Here are a few points to keep in mind:
Employers should pretty much always offer HRAs instead of HSAs to their employees. HRAs are way more flexible and allow reimbursement for health insurance premiums.
That said, HSAs are also great for many people. Regardless of what your employer is offering you, consider getting an HSA just like you would an IRA.
Health Reimbursement Arrangements and Plan Design – are relatively simple in scope. However, there are many design options that give employers’ flexibility and control over the health benefits that they offer employees. Below are examples of HRA plan design options and how they can be utilized.
A Stand-Alone HRA: Is not linked to a major medical plan, rather the HRA is the health benefit. Employers can reimburse for individual health insurance premiums, as well as other eligible out-of-pocket medical expenses.
An Integrated HRA: The most commonly-known type of HRA is one that is integrated with a high deductible major medical plan. The HRA is offered only to those who take the major medical coverage.
HRA Allowance and Frequency
What amounts would you like to allocate for each employee, and at what frequency will they be available (monthly or annually)? For example, an employee could have a $100 monthly HRA allowance, made available at the beginning of each month or an annual allowance of $1,200 made available at the beginning of the plan year. There is no minimum or maximum HRA contribution amount and all HRA funds are notional (paid only after the medical expense is substantiated).
HRA Classes and Eligibility
Will you have one benefit level for all employees, or give different HRA allowances by class of employee? With HRA class design, you can allocate different HRA allowances based on bona-fide job criteria such as job description, length of stay with the company, geographic location, part-time or full-time status, etc. ERISA and HIPAA allow this, as long as all “similiary situated” employees are treated equally.
Annual Rollover of Unused Funds
What will happen to employees’ unused HRA funds at the end of the plan year? You, the Employer have full control over this. An HRA can be designed with full rollover of unused funds, a capped rollover of unused funds (a maximum amount to rollover), or no rollover of unused funds (“use it or lose it”).
HRA Eligible Medical Expenses
What type of expenses do you want the HRA to reimburse? The IRS sets the definition for medical expenses that can be reimbursed through an HRA (see section 213(d) of the internal revenue code). From this list you can limit expense categories not to reimburse. Categories may include health insurance premiums, doctor’s visits, hospital care, pharmacy, mental health, physical therapy, etc.
HRA “EOB-Only” Requirement
Do you only want to reimburse expenses that were covered by a major medical plan? If so, you can require that all expenses are submitted with an Explanation of Benefits (“EOB”) which shows that the medical expense was covered under insurance. This is most common with an integrated HRA but can be applied to any HRA plan.
HRA Cost-Sharing Options
Would you like employees to share in the cost of their medical expenses? If so, you can design your HRA plan with an HRA co-insurance and/or deductible. For example, with an HRA co-insurance you could reimburse 80% of all eligible medical expenses. With an HRA deductible, employees could be required to pay out-of-pocket a certain amount per year before HRA funds are available to them.
Is there a certain type of expense you want to limit or cap? For example, within an employees’ annual HRA allowance, you can design their HRA to limit the amount reimbursed for certain categories of health care expenses. For example, a business could offer a $2,000 HRA annual allowance, with an annual limit of $500 for dental expenses.
Who is Eligible to Participate in the HRA?
Current or former W-2 employees, and their qualified dependents are eligible to participate in the HRA and receive reimbursements 100% tax-free.
Who are Qualified HRA Dependents?
A qualified HRA dependent must be a dependent per the IRS definition. Qualified dependents include a spouse, child(ren) or qualified relatives. For detailed definitions see: IRS Publication 502 (page 26)
Can an Owner Participate in the HRA?
Yes. However, whether or not owners can receive HRA reimbursements 100% tax free depends on how the company files, and the owner’s status.
C-Corporation Owners: C-Corp owners may participate in an HRA and receive all HRA reimbursements 100% tax-free.
Sole Proprietors, Partners, or S-Corp shareholders that own >2% of the company’s shares: These Non-C-Corp owners can use the HRA platform to reimburse and track medical expenses. However, HRA reimbursements must be reported on the owners’/partners’ wages (on their W-2 and 1040 forms) and are subject to federal income taxes.
Can 1099 Contractors Participate in the HRA?
Technically, the answer is no. However, many businesses can use specialized administrative software to offer health benefits to 1099 contractors. The primary difference is that, unlike W-2 employees, 1099 contractors must report all HRA reimbursements as income on their personal tax return.
Due to its flexibility, HRA software can be the ideal health benefits solution for 1099 contractors.
The 1099 contractors can only use the money on health insurance and medical expenses;
Unused amounts remain with the company when the 1099 contractor is no longer working with the company;
The plans help companies recruit and retain the most talented 1099 contractors.
Many 1099 contractors can already deduct 100% of the cost of their individual health insurance on their personal tax return.
The business is not required to pay payroll taxes on the reimbursements.
Can We Set Other Eligibility Requirements for HRA Participation?
Yes. Within your HRA plan design, you can set specific eligibility requirements for HRA participation such as a waiting period, length of stay with the company, part-time/full-time status, or enrollment in the company-sponsored group health plan. You can also choose if the HRA will reimburse employees only, or allow qualified dependents.