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Health insurance stipends pros and cons

Written by: Elizabeth Walker
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Published on September 6, 2022.

Many small employers who can't afford to offer formal health benefits decide to give employees a taxable stipend to use toward healthcare expenses. While this option is easy to administer and saves employers time, the value of these dollars is lessened because a health insurance stipend payment is considered part of employees' income—not a separate benefit.

This means that stipends have payroll and income tax implications that tax-free health benefits don't have. What's more, employers can't require employees to prove they purchased health insurance with their stipend money.

So is a health insurance stipend a worthwhile option after all? In this article, we'll examine the pros and cons of taxable health insurance stipends, outline best practices, and discuss a tax-free way to offer your employees health insurance.

Learn more about how employee stipends work with our complete guide

How does a health insurance stipend work?

With a health insurance stipend, employees receive a fixed, taxable stipend to purchase an individual health insurance plan and use it on out-of-pocket expenses.

This allows you to give them the option of getting a health insurance policy of their choice without having to foot the bill for group health insurance for all your employees, which can be more cost-effective for you considering rising healthcare costs.

The employer's monthly contributions are typically paid as wages on the employee's paycheck. You can choose to offer a stipend as a monthly allowance through an expense card or a lifestyle savings account (LSA), or you can reimburse your employees for their healthcare expenses.

Pros of a health insurance stipend

A stipend can offer some unique advantages. Among other benefits, employees will be open to multiple policy options and be able to compare and find the health insurance plan that best suits their needs.

A health stipend also allows you to easily provide a benefit to international workers and 1099 contractors without affecting their employment status.

Since a stipend isn't a formal health benefit, you can fully customize your stipend amounts to your organization's needs without any contribution limits.

A health insurance stipend could be a good idea for your business if…

  • You can't afford to offer a formal group health insurance plan.
  • You don't want to have to worry about any compliance or regulation considerations with the IRS, HIPAA, or ERISA.
  • You want something simple and easy to manage through automatic payroll additions.
  • You have employees who receive advance premium tax credits (APTC) for individual health insurance premiums.

Cons of a health insurance stipend

With a stipend, there's no requirement that employees need to use the money to purchase health insurance. You may trust that your employees will use the stipends for health insurance and other medical expenses, but you can't guarantee they will.

In addition, if employees view the stipend as part of their wages, and you later decide to remove it, they might see it as a pay cut. Doing this could lower morale.

Other cons of a health insurance stipend include:

  • Employers must pay payroll tax on reimbursements totaling 7.65%.
    • Employees are taxed on the amounts received as income, usually between 20% to 40%.
  • You can't require employees to submit proof of insurance, so it may not accomplish your intended objective of offering a health benefit.
  • Many prospective employees may not see a stipend as an actual “benefits package,” which could turn off the very people you were hoping to attract.

Best practices for health insurance stipends

Stipends are legal when you follow the tax laws in your area. While they've been used negatively in the past, stipends today are typically used as an added bonus alongside proper pay. As a general rule, stipends should never be used as a way to exempt an employee, either part-time or full-time, from a salaried position.

When offering employees a health insurance stipend, here are three best practices to consider:

  • Don't ask employees to show proof of health insurance.
    • Direct payment or direct reimbursement for health insurance is considered an employer payment plan, and the business could face penalties for asking for verification.
  • Treat the stipend as taxable income.
  • Continuously communicate to employees that the stipend is intended as a health benefit. This way, employees will be more likely to use it for medical reasons and not simply consider it as extra wages.

Stipends vs. health reimbursement arrangements (HRAs)

As mentioned, stipends are subject to payroll and income taxes, meaning employer dollars don't stretch as much. Thankfully there's a tax-free alternative to stipends.

A health reimbursement arrangement (HRA) is an IRS-approved, employer-funded health benefit meant to reimburse employees, tax-free, for qualifying out-of-pocket medical expenses and individual health insurance premiums.

Many employers prefer HRAs over healthcare stipends for better budget control and tax advantages. You determine how much tax-free allowance you want to offer your employees each month. Once an allowance is set, your payment amounts can't exceed it.

Employees choose the insurance and services they want and purchase them with their own money. Employees then submit proof of a purchased eligible expense, usually in the form of a receipt, and are reimbursed by the employer after the expense is verified.

Other pros of an HRA are:

  • They’re tax free. Reimbursements are free of payroll taxes for both employer and employee. They're also free of income taxes, as long as the employee has minimum essential coverage (MEC).
  • They require employees to use the money for medical expenses. Employees can only use the funds for eligible expenses under IRS Publication 502. Employers can design plans that restrict reimbursable expenses further.
  • They’re easy to implement. Companies like PeopleKeep have fully compliant and intuitive administration software to facilitate expense submission and reimbursement. A team of experts reviews all expense documentation to ensure you only reimburse employees for eligible expenses.
  • They help you attract and retain top talent. HRAs allow small and medium-sized organizations to offer a quality health benefit without breaking the bank.

PeopleKeep offers HRAs that work for any employer, regardless of your organization's size, group insurance status, or budget.

Three of the most popular types of HRAs include:

Conclusion

Health insurance stipends are one way to help employees with the cost of health insurance. They're cost-effective and easy to administer but are subject to taxes, and employees may treat them as a regular bonus.

If a health stipend is right for your business, PeopleKeep can help. Our WorkPerks benefits software enables organizations to easily set up their employee stipend benefits in minutes.

HRAs are another great way to reimburse employees for healthcare costs, but they're tax-free and are only allowed to be used on insurance premiums and other medical expenses.

If you believe an HRA or health stipend is the right choice for your organization, schedule a call with a personalized benefits advisor, and we'll get you on your way

This blog article was originally published on August 25, 2020. It was last updated on September 6, 2022.

Originally published on September 6, 2022. Last updated September 6, 2022.
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