Pure defined contribution health plans are quickly becoming the future small business health insurance. In this article, we provide background on defined contribution health plans and outline the steps an employer would go through to set up a pure defined contribution plan.
When discussing defined contribution, we are referring to a pure defined contribution health plan where the business provides a fixed healthcare allowance (a "defined contribution") that employees can spend on personal health insurance policies.
How Defined Contribution Health Plans Work
The shift from employer sponsored plans (a "defined benefit") to defined contribution health plans is similar to the shift in retirement savings from pensions (a defined benefit) to 401Ks (a defined contribution). After realizing the savings associated with moving away from defined benefit retirement plans, many businesses are also applying this model to their healthcare benefit programs.
In the early 2000s, the IRS began allowing employers to establish medical reimbursement plans to reimburse employees tax-free for certain medical expenses, including premiums paid for individual health insurance. This is similar to the way employers routinely reimburse employees for travel, meals, and other qualified business expenses. This type of medical reimbursement plan is governed by IRS Code Section 105, and is sometimes referred to as a Section 105 Plan.
With a pure defined contribution health plan, employees purchase health insurance and then submit documentation for reimbursement in accordance with the rules of the specific plan document.
How to Set Up a Defined Contribution Health Plan
To set up a defined contribution health plan, employers should utilize a formalized plan to ensure compliance with the ACA, the IRS, HIPAA, and ERISA. Because of new ACA reforms, most companies will use a limited purpose Section 105 medical reimbursement plan, such as a limited Healthcare Reimbursement Plan (HRP), as the foundation of their defined contribution health plan.
And because of the HIPAA and compliance considerations, virtually all companies use a third-party to handle verification of medical expenses and/or reimbursement to employees.
See more: Why Use Defined Contribution Software?
4 Step Setup for a Defined Contribution Health Plan
There are four steps to setting up a Pure Defined Contribution Health Plan:
Step 1: Do not offer a group health insurance plan.
Step 2: Define any amount you can afford for health benefits and use Defined Contribution Software to set up formal plan documents and to give each employee a fixed allowance amount to use for individual health insurance.
Step 3: Select an Insurance Professional, and/or provide information about the new Health Insurance Marketplaces to help employees shop for and purchase individual health policies (typically, this saves the employee 20-30%).Step 4: Use Defined Contribution Software to reimburse employees via payroll.
Defined Contribution Plan Design Customization
Lastly, there are three plan design questions to further customize a defined contribution plan.
1. When will the plan year start?
Decide when the Defined Contribution Health Plan will start, and when the plan year will run. For example, you may decide to start the plan on June 1, but going forward have a plan year of January 1 to December 31.
2. What monthly allowance amounts will you provide?
You probably already have a budget in mind for health benefits. Within this budget, how will you divide up employees' monthly allowances?
You can provide the same monthly allowance amount to all employees, or you can provide different monthly allowances to different types of employees. This is also called employee classes. Classes must be based on bone-fide job criteria such as job title, location, etc. You can also vary the allowance amounts by family status (single, married, etc.) within an employee class.
For example, you could provide $300/month to Senior Programmers and $150/month to Administrative staff.
Following this example, you could add a layer of family status allowances. For the Senior Programmers you could provide $300/month to single participants, $350/month to married participants, and $400/month to married with children participants.
3. When are employees eligible for the plan?
What criteria makes employees eligible to participate in the Defined Contribution Health Plan? For example, do they need to work a certain amount of hours, or been employed for a certain number of days? (Note: the maximum waiting period is 90 days). This criteria will set employee eligibility for the Defined Contribution Health Plan.
Do you have questions about how to set up a defined contribution health plan? Leave a comment below.