Pros and Cons of Stand-Alone HRAs

June 12, 2013

As a small business evaluates how to offer employees health insurance, they will likely consider a stand-alone HRA. Stand-alone Health Reimbursement Arrangements (HRAs) are an IRS-approved vehicle that allows small businesses to provide employees with tax-free contributions to their individual health insurance premiums and out-of pocket medical expenses. With a stand-alone HRA, a small business offers employees a "business expense" type of health benefit, as an alternative to a traditional group health insurance plan. Stand-alone HRAs are also referred to as "pure" defined contribution plans.

pros and cons of HRA

So, what are the pros and cons of stand-alone HRAs for a small business, and for employees? 

Stand-Alone HRAs: Pros for Small Businesses

The four main pros of stand-alone HRAs for small businesses are: flexibility, employer control, tax savings, and employee recruitment and retention.

  • Flexibility: First, stand-alone HRAs are extremely flexible for small businesses. A small business can design the HRA Plan in a variety of ways to meet their budget and hiring needs. For example, the small business decides the amount to contribute to employees' HRA allowances, what types of medical expenses to reimburse, and what happens to the funds at the end of the year. In other words, with HRA plan design, virtually anything goes.

  • Control: With stand-alone HRAs, the small business owns the HRA funds and the HRA is entirely employer-funded. HRA reimbursements are only issued to employees once they show proof of the expense. Additionally, when the employee leaves the business, any unused HRA funds generally stay with the business.

  • Tax Savings: Stand-alone HRAs reduce the amount of FICA and FUTA tax. Small businesses can deduct HRA reimbursements as a business expense, and exclude them from wages subject to FUTA (0.8%) and the employer portion of FICA (7.65%).

  • Recruitment & Retention: Many small businesses struggle to afford group health insurance, or cannot meet participation requirements. Offering a stand-alone HRA as the sole employee health benefit allows a small business to offer (and advertise) health benefits when recruiting key employees.

Stand-Alone HRAs: Pros for Employees

The five main pros of stand-alone HRAs for employees are: the benefits of pre-tax dollars, choice of plans, plan portability, plan value, and federal premium tax subsidies in 2014. 

  • Pre-Tax Dollars: Employees save 20-40% on medical expenses by using pre-tax dollars rather than after-tax dollars. And, HRA reimbursements from are generally excluded from employees' gross income.

  • Choice of Insurance Plan: With a stand-alone HRA, employees choose the individual health insurance plan best for them. Employees can choose from any carrier, and any type of plan (HMO, PPO, HDHP, etc.). Additionally, employees can use the HRA to cover the cost of supplemental coverage like dental or vision insurance, or other qualified medical expenses, with pre-tax dollars.

  • Insurance Plan Portability: With stand-alone HRAs, employees are purchasing individual health insurance plans. Since individual health insurance plans belong to the employee (not to the small business), the plan stays with employees if they leave the business. 

  • Less Expensive Insurance Policies: In general, the cost of individual/family health insurance premiums costs a third the price for similar group coverage in 45 states. This is primarily because insurance carriers in 45 states are allowed to (until 2014): base price on age, and/or deny coverage or charge more to applicants for preexisting conditions.

  • Federal Individual Premium Tax Subsidies in 2014: Starting in 2014, most employees will have access to significant premium tax subsidies through their state health insurance marketplace. For example, if an employee is eligible for a tax credit, their cost of health insurance will be capped at 2% - 9.5% of household income. An employee is eligible if their household income is less than 400% above the federal poverty line ($94,200 per year for a family of 4 in 2013). 

Stand-Alone HRAs: Cons for Small Businesses

So, what about the cons of stand-alone HRAs? 

  • A Change in Benefits Administration: Offering a stand-alone HRA changes the role of offering health benefits from a plan management role to a payroll function. Some small businesses perceive HRA administration as a con of offering an HRA. And, with the wrong HRA administrator this can be true. What's the work around? Use an online HRA software to completely alleviate this. With the right HRA software, HRA administration takes 5-10 minutes a month.

  • Limited Tax-Benefits for Some Owners: With stand-alone HRAs, some types of business owners receive limited tax benefits from HRA reimbursements. In other words, some business owners may need to report HRA reimbursements as taxable income. Read more on small business owner participation in HRAs.

Stand-Alone HRAs: Cons for Employees

Likewise, there are some perceived cons for employees with stand-alone HRAs. With planning, education, and the right HRA administrator, these concerns can be addressed:

  • Reimbursements are Just That...: With a stand-alone HRA, employees must show proof of their insurance premium and medical bills before being reimbursed. To significantly alleviate this, small businesses should use HRA software that provides same-day processing of employees' HRA reimbursement requests ("claims").

  • Change is Hard: Let's be honest, a stand-alone HRA is a significant change in how small businesses offer health benefits, and how employees receive them. Even with all of the employee benefits listed above, it still means employees take on a new responsibility of managing their own health benefits. Employees become health insurance consumers (just like they are a car insurance consumers). What makes all the difference? Work with an insurance broker to help employees choose individual health insurance policies, and choose an HRA administrator that will help educate, train, and support employees on the stand-alone HRA.

What are other pros and cons of stand-alone HRAs? Let us know in the comments below.

The Comprehensive Guide to the Small Business HRA

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