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Small Business Employee Benefits and HR Blog

Top 5 Questions on Defined Contribution Plans

July 30, 2013
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Whether you're an insurance broker helping a client set up a defined contribution health plan, or a small business considering the advantages of a defined health contribution plan, we've compiled a list of the top five questions about defined contribution plans.

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#1) What is a defined contribution plan?

A defined contribution plan is technically not a health insurance plan. Rather, it is a strategy for offering health benefits.

With a defined contribution plan, a company gives each employee a fixed dollar amount that the employees can use to purchase individual health insurance and other eligible medical expenses such as dental, prescriptions, co-pays, etc. The company has flexibility in how they design the plan, full control of the cost, and the strategy provides access to health insurance that employees value.

Tip: We are talking about "pure" defined contribution plans, where there is not an employer-sponsored group health insurance plan (or specific menu of plans) offered.

#2) Why are companies switching to defined contribution plans now?

History Future

To understand why companies are switching to defined contribution plans now, it's important to understand where we've been historically with health insurance. Since the introduction of group health insurance plans (a defined health benefit) post WWII, group health insurance has held the majority of the health insurance market.

Since WWII, group health insurance policies enjoyed enormous tax advantages over individual plans because:

  1. Employers were allowed to pay for group health insurance pre-taxed, “off the books”

  2. Employees were allowed to pay (via salary reduction) for group health insurance, also pre-taxed, “off the books”

But, the rising cost of health care has caused employers of all sizes to re-evaluate how much they pay for insuring their employees. Defined contribution plans provide a solution to the cost concerns of traditional group health insurance because companies define and control all the costs with a defined contribution plan. Lastly, the availability of Section 105 medical reimbursement plans in 2002 allowed defined contribution health plans the same tax benefits to employers and employees.

For more history on defined contribution plans, see this guide.

#3) What are the other benefits of defined contribution plans, besides cost predictability?

Cost is a key factor in offering employees health benefits, but cost is not always the only consideration for companies. Companies also switch to defined contribution plans because:

  • Contributions can be tax-free (when the defined contribution plan is set up using a compliant Section 105 Healthcare Reimbursement Plan).

  • Defined contribution plans allow for employer flexibility of plan design.

  • Defined contribution plans are easy for HR to administer.

  • Defined contribution plans allow the company to get out of the health insurance business. 

#4) What do employees think about defined contribution plans?

While defined contribution plans are a change in the way companies offer access to health insurance, and in
the way employees receive benefits, employees value defined contribution plans because:
  • Employees have access to the best health care, including choosing a plan from any carrier and access to their preferred network of providers and doctors.

  • Starting in 2014, all employees will be covered, guaranteed, through an individual health insurance plan.

  • Employers can give employees access to the health insurance subsidies (through the new health insurance marketplaces, available in 2014).

  • Predictable costs for employees.

For more on how defined contribution plans help companies offer better benefits to employees, see this article.

#5) How much time does it take to administer a defined contribution plan?

With defined contribution plans, administration becomes a payroll function. Once set up, it takes 5-10 minutes a month.

Have we answered the top 5 questions about defined contribution health plans? If not, let us know your questions in the comments below and we'll answer them.

Defined Contribution Guide

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