How to give your employees a health insurance stipend

Benefits can be hard, so employers often ask if they can give their employees a health insurance stipend. Yes, they can give their employees money to pay for healthcare in a few different ways. Thatch will discuss two—health insurance stipends and health reimbursement arrangements. The pros and cons of each option and the legal and tax implications will be outlined.

Healthcare Stipends

The most basic option is just to give employees extra money outright to pay for health care. This is called a health insurance stipend.

A health insurance stipend is essentially a predetermined amount of money paid to employees that can be used to cover healthcare expenses. This can include health insurance premiums, medical bills, dental care, vision care, or even wellness programs. The stipend is added to an employee's regular paycheck and is treated as taxable income, meaning you, as the employer, are liable for payroll taxes, and the employee is liable for income taxes on this amount.

For example, you may decide that you want predictability and want to avoid setting up and administering benefits, but you like the idea of providing your employees with some amount of money they can use to find their own health insurance plan. You can give them a healthcare stipend and they can use it to pay for health insurance, medical bills, and more. But you need to be aware of legal, compliance, and tax implications.

Benefits of offering a health insurance stipend

• Flexibility. Employees can choose the healthcare plan or services that best suit their needs.
• Simplicity. Employers can avoid the complexities involved in offering healthcare benefits directly.
• Cost-effective. The employer and employee know exactly what will be spent each month on healthcare, making budgeting easier.

Drawbacks of health insurance stipends

• Tax implications. Health insurance stipends are considered taxable income, so many employers instead choose to set up a tax-advantaged reimbursement system like an ICHRA 
• Limited oversight. Employers have less control over how the stipend is spent. You might want to ensure that employees are using the stipend for healthcare-related expenses, but you can't require them to provide proof of how they spent the money.
• Possible inadequacy. The stipend might not be enough to cover an employee's total healthcare costs. In addition, the Affordable Care Act requires that Applicable Large Employers (ALEs) (employers with at least 50 full-time employees on average during the prior calendar year) are generally required to offer affordable care to 95% of employees and their dependents to avoid penalties under the Employer Mandate, and healthcare stipends are generally inadequate.

How to set up a healthcare stipend

Considering a health insurance stipend for your employees? Here are some steps to get you started in the process:

• Budget assessment. Determine how much you can afford to provide as a defined contribution.
• Legal consultation. Speak with a tax advisor or legal counsel to ensure the stipend program complies with federal and state laws, and to make sure that you've satisfied any obligations under the ACA.
• Employee survey. Optionally, survey your employees to determine their healthcare needs and priorities.
• Define an allowance. Decide on the stipend amount. 
• Communicate. Communicate the stipend program to your employees, explaining what it covers and how to access it.

Tax Considerations

As mentioned before, health insurance stipends are considered taxable income. This means that both the employer and employee are liable for paying taxes on the stipend. The employer must pay payroll taxes on the stipend, and the employee must pay income taxes on the health insurance stipend.

If you want healthcare spending to be tax-free, consider setting up a Health Reimbursement Arrangement (HRA) or another tax-advantaged arrangement. 

Legal considerations of a health insurance stipend

Health insurance stipends are not subject to the same regulations as traditional group health insurance plans. However, there are still some legal considerations to keep in mind.

• Open to all. The health insurance stipend must be offered to all employees for the same amount, regardless of health states, age, or other factors.
• Taxes. Health insurance stipends are taxable for both the employee and employer.

Communication. You can remind your employees that they can use their stipend on healthcare. This way, they could be more likely to use it to cover their health insurance costs.

Health Reimbursement Arrangements (HRA)

HRAs like ICHRAs are tax-advantaged arrangements that can be used to reimburse employees for healthcare expenses. The employer uses the ICHRA to reimburse employees for health insurance premiums, medical bills, dental care, and vision care. The employer can set up an HRA for each employee or a group of employees.

Pros of offering an HRA

• Tax advantages. HRAs are tax-advantaged arrangements, meaning that the reimbursement is not subject to payroll taxes. Likewise, employees aren't required to pay income taxes on the money they receive from the HRA. This makes HRAs a much more cost-effective option—for both employers and their teams—than health insurance stipends.
• Efficient and controlled budgeting. ICHRAs and HRAs in general are much more efficient because everyone uses the money in the way that's best for them. With an ICHRA, you can also create custom classes for your employees; so you can offer different amounts to different employees in different age ranges or geographic locations, for example. This is important because costs vary widely across the country, and you want to ensure that your employees get the best value for their money.
• Flexibility. Just like with a health insurance stipend, your employees will choose their own healthcare plan or services. HRAs can be helpful because they can be used to cover a wide range of healthcare expenses, from insurance premiums, prescription drugs, therapy, medical bills, dental services, vision care, or anything else under IRS Publication 502.
• Simplicity. HRAs are much simpler to set up and administer than traditional group health insurance plans. You don't have to worry about choosing a plan, negotiating rates, dealing with issues that arise, or handling claims. You just set up the HRA and let your employees use it to pay for their healthcare expenses.

Cons of offering an HRA

• More work for employees. Because employees have a budget they can allocate however they like, there's typically more work involved in finding and selecting a plan. Employees must have the right tools to help them make the best decision for their needs. 
• Requires some setup. If you decide to set up the HRA, choose a third-party administrator and ensure that the HRA complies with federal and state laws.

Tax considerations

For employers, the contributions made to an HRA are tax-deductible as a business expense. This allows companies to better predict and manage healthcare expenses while reaping tax benefits, and in turn, providing a financial incentive to offer such arrangements.

For employees, reimbursements received through an HRA can be tax-free when used for qualified medical expenses, as defined by the Internal Revenue Service . This means that employees can pay for various medical costs, ranging from premiums to copayments, without subjecting those funds to federal, and often state and local, income taxes. However, it's crucial to note that strict guidelines and regulations govern the use of HRA funds, and any money reimbursed for nonqualified expenses could be subject to taxation.

All costs must be substantiated with receipts or other documentation, so employers typically manage their HRA through a third-party administrator.

Choosing the right option for your business

Providing a health insurance stipend offers flexibility for your employees and simplicity for your business. However, it's not as straightforward as it seems—it's crucial to understand the associated pros, cons, and legal considerations. HRAs like the ICHRA are super powerful but come with administrative complexity and compliance obligations. An employee benefits broker can help with this if needed.

This story was produced by Thatch and reviewed and distributed by Stacker.