Every day at Zane Benefits, we talk to small businesses that do not offer health benefits. Often, these employers consider giving raises in place of health reimbursement arrangements (HRAs) due to the administration fees associated with compliant HRA administration. A taxable raise in an employee's paycheck may seem "cheaper", but it is not the "cheapest" option. Here's why:
The employer pays taxes on the raise. An annual raise of $300 per month gross actually costs the employer $322.95 per month when you factor in payroll taxes (7.65%). In other words, the employer is spending $3,875.40 in order to offer a pre-tax raise of $3,600.
The employees pay taxes on the raise. Assuming the employee is 1) single and 2) making $35,000+, the employee must pay $1,175.40 of the $3,600 in taxes ($3,600 * 32.65%*). In other words, the employer is spending $3,875.40 in order to offer an after-tax ("take home") raise of $2,424.60.
Extra income is typically spent on consumer goods. It is unlikely that the salary increase will be put towards the purchase of health insurance.
*25% marginal tax rate plus 7.65% FICA/FUTA
The Solution: Give Employees A Tax-Free HRA Allowance vs a Taxable Raise
With a health reimbursement arrangement (HRA), the company gives each employee a fixed dollar HRA allowance the employees choose how to spend. Employees then use their HRA to reimburse themselves for out-of-pocket health insurance costs or other medical expenses 100% tax-free.
The reimbursements are:
Tax deductible to the business
100% tax-free to employees
As a result, $1 in an HRA may be worth $1.50 - $2.00 in a taxable raise depending on the employee's tax bracket.
Additionally, the $1 in HRA costs the company less than a $1 raise. (Remember, it's tax deductible to the business so the company does not have to pay payroll taxes!)
Here's how it works:
The business sets the HRA allowances (the allowances can be varied based on employee job classifications, and there is no "minimum contribution")
The business decides what expenses can be reimbursed by the HRA (eligible expenses include health insurance premiums, dental expenses, doctor visits, etc.)
The business decides who is eligible for the HRA (the employer can restrict eligibility based on job classifications, and there is no "minimum participation")
By offering an HRA, the employer can provide a full $300 per month increase in "take-home" compensation, at a lower cost.
Best of all, if the employee does not use the HRA to reimburse qualified medical and insurance expenses, the employer retains the unused HRA dollars.
Is it really worth giving a raise in place of health benefits via an HRA?