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Small Business Employee Benefits and HR Blog

Does Offering 'Pure' Defined Contribution Disqualify Employees from Individual Premium Tax Credits?

A common question is "does offering a pure defined contribution health plan disqualify employees from the individual premium tax credits?" The answer is no.give the gift of premium subsidies with defined contribution

Employees who receive a healthcare allowance through a pure defined contribution plan can still access premium tax credits, as long as they meet other eligibility criteria based on household size and income.

This is because, set up correctly, a pure defined contribution healthcare allowance is not an "eligible employer-sponsored plan". Therefore, offering a defined contribution healthcare allowance to employees does not disqualify them from the individual premium tax credits.

What is the Definition of an Eligible Employer-Sponsored Plan?

According to 26 USC Section 5000A(f)(2):

The term “eligible employer-sponsored plan” means, with respect to any employee, a group health plan or group health insurance coverage offered by an employer to the employee which is—

(A) a governmental plan (within the meaning of section 2791(d)(8) of the Public Health Service Act), or

(B) any other plan or coverage offered in the small or large group market within a State.

Such term shall include a grandfathered health plan described in paragraph (1)(D) offered in a group market.

A pure defined contribution plan is not 1) a governmental plan, or 2) offered in the small or large group market within a state, so the defined contribution plan is not an "eligible employer-sponsored plan".

Tip: Care must be taken in the design and administration of the pure defined contribution plan to ensure the plan does not meet the definition of an eligible employer-sponsored plan in IRC Section 5000A and consequently qualify as minimum essential coverage. This ensures employees participating are able to receive the premium tax credit, assuming they meet additional eligibility criteria.

What are the Individual Premium Tax Credits?

As of 2014, significant tax credits are available to help employees buy individual health insurance coverage through the new state health insurance marketplaces.

The tax credits will only be available to employees who enroll through the state's individual health insurance marketplace and who are not offered coverage in an "eligible employer-sponsored plan" (through their employer or a family member's employer). Employees are eligible if their household income is less than 400% of the FPL (up to $94,200/year in 2013 for a family of four).

If an employee is eligible for these tax credits, the premium they'll pay for coverage will be capped at 2% - 9.5% of their household income. 

For more details on eligibility and the credit amount see: What is my Individual Premium Tax Credit? 

How Employers Can Achieve Costs Savings with the Individual Premium Tax Credits

Employers can take advantage of these individual premium tax credit savings, and continue to offer employees a valuable health benefit, by offering a pure defined contribution plan. Employees purchase policies on the marketplace, access the individual premium tax credits, and are reimbursed for the non-subsidized portion of their premium - up to the amount of their healthcare allowance. With this model, both the business and employees save a combined 50% on health insurance costs.

Also, since a pure defined contribution plan is not an "eligible employer-sponsored plan", it does not satisfy the "play or pay" requirement (also called employer mandate or employer shared responsibility payment). However, this play or pay requirement is only applicable to businesses with 50+ full time equivalent (FTE) employees, and has been delayed until 2015.

  • For businesses with less than 50 FTE employees, a pure defined contribution plan combined with individual health insurance is a no-brainer.

  • Businesses with 50+ FTE employees should conduct a cost analysis to compare the cost and benefits of (1) offering group health insurance, (2) offering nothing, or (3) accepting any applicable tax penalties and offering pure defined contribution health plan.

How would this work in "real-life"? See this example of defined contribution and premium tax credits.

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