Can section 125 plans be used with an ICHRA?

Determining which health benefits to include in your compensation package can be difficult, especially if you want to offer a variety of tax-advantaged options. Section 125 plans and individual coverage health reimbursement arrangements (ICHRAs) are two popular benefits that can help employees save money on healthcare expenses. But there are specific IRS rules on how they can work together.

In some cases, a Section 125 plan can integrate with an ICHRA to maximize employees’ tax savings. However, employees must meet certain conditions to do so, such as buying their individual health plans from eligible health insurance marketplaces.

Understanding when these two employee benefits can and can't work together can help employers design a comprehensive health benefits package while avoiding compliance errors.

In this blog post, you’ll learn:

• When employees can legally combine a Section 125 cafeteria plan with an ICHRA.
• Why individual health insurance purchased through a public exchange is different than off-exchange plans.
• If employers can administer these benefits by partnering with PeopleKeep and Remodel Health.

What is a Section 125 plan?

An IRS Section 125 plan, also called a cafeteria plan, is an employer-sponsored benefit that allows employees to set aside a portion of their total gross wages and contribute it toward certain qualified expenses before federal, state, and local taxes are deducted. Section 125 plans are popular because they can reduce an employee’s taxable income by the amount they contribute to the plan. Employers can also significantly lower their payroll tax obligations.

There are many different types of Section 125 plans, but one of the most common is a premium-only plan (POP). A POP enables employees to pay for eligible health insurance premiums with pre-tax dollars through payroll deductions.

While employers often use Section 125 plans alongside traditional group health insurance, they can also work with certain other benefits, including ICHRAs, in certain situations.

What is an ICHRA?

An ICHRA is an IRS-approved health benefit that allows employers of all sizes to reimburse employees tax-free for individual health insurance premiums and other qualified medical expenses. Instead of offering a limited traditional group health plan to all your employees, employers provide each employee with a monthly allowance that they can use to buy individual health coverage and eligible healthcare costs.

Here's how an ICHRA works:

• The employer sets a monthly reimbursement allowance for eligible employees. They can customize this allowance using employee classes, age, and family size.
• Eligible employees choose and enroll in a qualifying individual health insurance plan that provides minimum essential coverage (MEC) on a public or private exchange.
• Medicare Parts A and B together or Medicare Part C coverage also qualify as individual coverage.
• Employees pay their plan’s monthly premiums and eligible medical expenses upfront. Then they submit proper claim documentation for reimbursement, such as a receipt or detailed invoice.
• Some ICHRA administrators provide premium payment features that bypass the traditional reimbursement method. We’ll explain this concept more later.
• Once the employer or ICHRA administration reviews the documentation and approves the purchase, the employee receives a tax-free reimbursement up to their available monthly allowance.
• ICHRAs also come with tax benefits. Contributions are tax-deductible and payroll tax-free for employers. Reimbursements are also exempt from income taxes for employees.

ICHRAs offer employers and employees greater flexibility than traditional group health plans. There are no contribution limits, no participation requirements, and employers can customize eligibility rules using legitimate employee classes. Applicable large employers (ALEs) can also use an ICHRA to satisfy the Affordable Care Act's employer mandate, as long as they meet affordability standards.

ICHRAs offer employees the flexibility to access the health coverage and medical services that they need while allowing employers greater budget control, making them an attractive benefit that’s rising in popularity nationwide, regardless of industry or company size.

Can Section 125 plans be used with an ICHRA?

Yes, but it depends on what type of health plan the employee purchased and whether the ICHRA administrator supports this. An ICHRA allows employers to contribute toward employees’ individual health plan premiums, while a Section 125 POP allows employees to use pre-tax payroll deductions to pay for their share of the plan’s premiums. However, this coordination only works if an employee buys an off-exchange health plan¹.

If an employee enrolls in qualified individual coverage through a public exchange, such as HealthCare.gov or a state-based marketplace, they can't use a Section 125 cafeteria plan to pay for any remaining premium amount after their ICHRA contribution. This is because public exchanges offer other tax subsidies, such as premium tax credits. Even though ICHRA participants are ineligible to receive these subsidies, the IRS doesn’t allow “double-dipping” with additional pre-tax reductions for individual premiums.

However, if the employee buys an off-exchange individual health policy on a private exchange, such as directly from an insurance carrier, a Section 125 plan can cover premium costs that exceed the employer's monthly ICHRA allowance.

Your ICHRA administrator would also need to offer a premium payment solution or payroll integration that allows the employer to make a salary reduction.

For example, suppose an employer offers employees an ICHRA with a monthly allowance of $450, and an employee purchases an off-exchange individual health plan that costs $600 per month.

In this scenario, their plan exceeds their ICHRA allowance, with $150 remaining as the employee’s cost. Because they bought an off-exchange policy, they can pay the $150 through their Section 125 cafeteria plan using pre-tax payroll deductions, reducing their out-of-pocket costs and improving the employee experience.

If the employee had purchased a marketplace policy through a public exchange, they couldn’t use their POP to pay for the $150. Unless they had another eligible benefit, they would have to pay their balance out of pocket.

Can you use a Section 125 plan with an ICHRA if you administer your benefit with PeopleKeep by Remodel Health?

PeopleKeep's ICHRA administration software uses a reimbursement-based model to simplify usability and compliance for employers and employees. Because we only offer a reimbursement-based platform, we can’t administer Section 125 premium-only payroll deductions alongside an ICHRA.

However, if you’re looking for this feature, consider ICHRA+® by Remodel Health, our parent company. ICHRA+ is an administrative solution for organizations that need comprehensive implementation support and advanced benefit options, such as compliantly combining an ICHRA with a Section 125 plan for eligible employees.

When you partner with Remodel Health, your employees can compare and purchase off-exchange Section 125 plans directly from our platform. Then, you can design your benefit to allow pre-tax payroll deductions for premiums that exceed your employees’ ICHRA allowances. Remodel Health’s AutoPay technology processes premium payments with over 99% accuracy and pays insurers directly, so you and your employees have peace of mind.

Learn more about Remodel Health’s ICHRA+ and how it compares to PeopleKeep’s ICHRA

Conclusion

Section 125 plans and ICHRAs are great ways to help your employees save money on medical costs and lower their tax liability. However, combining a Section 125 plan with an ICHRA is all about knowing the rules. Whether an employee prefers a public or private exchange, the key to successful benefit coordination is making sure they understand how their benefits interact and where they should shop for coverage if they want the best bang for their buck.

If you’re wondering whether an ICHRA is right for your organization or you have questions about how to design it to work with other benefits, PeopleKeep by Remodel Health can help. Book a call with one of our HRA specialists to see how we can make offering a customized ICHRA to your employees easy.

This blog article was originally published on August 7, 2020. It was last updated on August 10, 2026.

References

1. Health Reimbursement Arrangements and Other Account-Based Group Health Plans