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Small Business Employee Benefits and HR Blog

Creating a Defined Contribution Health Benefits Budget in 3 Easy Steps

December 31, 2013

Determining a budget for defined contribution health benefits is quite simple, because the cost of defined contribution is 100% controlled by the employer. This is one of the major benefits of offering health benefits with a "pure" defined contribution approach, and the reason why many small businesses and nonprofits are able to offer health benefits for the first time. Budget_for_defined_contribution_health_benefits

This article provides a brief overview of defined contribution health benefits and outlines the three easy steps to create a defined contribution health benefits budget.

What are Defined Contribution Health Benefits?

Defined contribution is a health benefits strategy. Rather than paying the costs to provide a specific group health insurance plan, an employer can fix their costs on a monthly basis by establishing healthcare allowances that employees may spend on qualified health insurance. Here's the general concept of "pure" defined contribution health benefits:

  1. Do not offer a group health insurance plan.

  2. Define any amount you can afford for health benefits and use Defined Contribution Software to give each employee a fixed dollar amount to use for individual health insurance. 

  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%).

  4. Use Defined Contribution Software to reimburse employees on payroll.

Defined contribution health benefits are an affordable alternative to an traditional group health insurance plan that helps employers recruit and retain employees. For more background, see: Defined Contribution Health Plans "For Dummies".

How to Create a Defined Contribution Health Benefits Budget

As mentioned earlier, if the employer wants to contribute any amount to employees' healthcare costs, they can afford "pure" defined contribution health benefits.

To budget for, and calculate the cost of the health benefits, follow these three simple steps. We’ve provided an example of defined contribution health benefits for a 10-person company.

Step 1: Determine the monthly and annual health benefits budget

What is the overall budget you will contribute to employee health benefits?

For example, if your annual budget is $18,000 for employee health benefits, the monthly budget is $1,500.

Step 2: Back out Employees' Defined Contribution Allowance Amounts

Within the overall budget, set employees' allowance amounts.
  • For example, if the monthly health benefits budget is $1,500 and the business has 10 employees, employees' defined contributions allowances could be $150/month.

  • Or, the business can customize the health benefits further with employee classes. With employee classes, a business can set different allowances by class of employee. Following the example of the 10-person company with a monthly budget of $1,500, they could allocate $200/month to the 2 managers and $137.50/month to the 8 retail staff.

Tip: With Defined Contribution Software, the allowances are notional, meaning the employer holds the allowance funds until a reimbursement is due. Then, they reimburse the employee directly (usually on payroll). Employers are not required to pre-fund the allowances in third-party bank accounts, which frees up cash flow for the business.

Step 3: Adjust for Defined Contribution Software/Administration Fees

Factor in Defined Contribution Software administration fees.

Fees will vary by provider and are usually a one-time set up fee and a monthly per participant administration fee. As needed, adjust employee allowance amounts to stay within your overall budget.

What questions do you have about creating a defined contribution health benefits budget? Leave a comment or question below.

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