SIGN UP

Health insurance stipends pros and cons

Written by: Elizabeth Walker
October 22, 2021 at 9:46 AM

Many small employers who can’t afford to offer formal health benefits decide to give employees a taxable stipend to use toward healthcare. While this option is easy to administer and saves time, the value of these dollars is lessened because a health insurance stipend 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 look at the pros and cons of taxable health insurance stipends, outline best practices, and discuss a tax-free way to offer your employees’ health insurance.

Want to jump ahead? Skip to a section below!

How does a health insurance stipend work?

With a health insurance stipend, employees receive a fixed, taxable stipend to purchase individual health insurance. 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 of your employees, which can be more cost effective for you considering rising healthcare costs. The employer's monthly contributions are typically added to the employees’ paycheck as wages.

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 comparison shop and find the health insurance plan that will best suit the needs of themselves and their family.

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 that’s simple and easy to manage through automatic payroll additions.

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 that they will.

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

Other cons of a health insurance stipend include:

  • Employers must pay payroll tax on reimbursements totaling 7.65%.
    • (6.2% for social security and 1.45% for Medicare)
  • 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 actually see a stipend as a real “benefits package,” which could turn off the very people you were hoping to attract.

See how much employers save by switching to a tax-advantaged HRA with PeopleKeep

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.

Curious if your health plan is considered compliant? Use our flowchart to find out.

Stipends vs. health reimbursement arrangements (HRAs)

As mentioned, stipends are subject to both payroll and income taxes, which means employer dollars don’t stretch as much. An HRA is an IRS-approved, employer-funded health benefit meant to reimburse employees, tax-free, for out-of-pocket medical expenses and health insurance premiums.

Many employers prefer HRAs over healthcare stipends because of 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, it can’t be exceeded.

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 expenses considered eligible under IRS publication 502. Employers can design plans that restrict reimbursable expenses further.
  • They’re easy to implement. Companies like PeopleKeep have a fully compliant and intuitive administration software to facilitate expense submission and reimbursement. A team of experts review all expense documentation to ensure you are only reimbursing 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: the qualified small employer HRA (QSEHRA), the individual coverage HRA (ICHRA), and the group coverage HRA (GCHRA). Better yet, HRA administrators like PeopleKeep make benefit management easy, saving you time to focus on building your business.

Download our HRA comparison chart to find out which HRA is best for you organization

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 they are subject to taxes and employees may treat it as a regular bonus. If you’re concerned that your employees won’t use the stipend you provide to pay for health insurance, you might want to look into other health benefit options, such as an HRA.

HRAs are a 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 is the right choice for your organization, schedule a call with a PeopleKeep personalized benefits advisor and we’ll get you on your way!

This article was originally published on August 25, 2020. It was last updated October 22, 2021.

Topics: Health Reimbursement Arrangement, Health Insurance Stipend, Qualified Small Employer HRA, Individual Coverage HRA

Additional Resources

Get our guide on how to offer health benefits with a small budget.
Learn how to help your employees get their health costs reimbursed.

Comments