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What are the Pros and Cons of Health Insurance Stipends?

July 22, 2015
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Many small employers who don’t offer formal health benefits give employees a taxable raise or bonus to use toward health care. While giving employees a lump sum for health insurance is allowed, the employer can’t require employees to prove they purchased health insurance. We’ll talk more about why that’s important later.

In this article, we’ll look at the pros and cons of giving employees a taxable health insurance stipend, outline best practices, and discuss a tax-free way to help employees with health insurance.

Pros of a health insurance stipend

With a health insurance stipend, employees receive a fixed, taxable stipend to purchase individual health insurance, whether or not they purchase health insurance. The employer's monthly contributions are typically added to their paycheck.

Pros of a health insurance stipend:

  • It is not a group health plan, so the employer doesn’t have any compliance considerations or management overhead.
  • It is simple and easy to manage through automatic payroll additions.

Cons of a Health Insurance Stipend

While a health insurance stipend is easy, it is not without drawbacks.

Cons of a health insurance stipend:

  • 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 (20 to 40 percent).
  • Employees aren’t required to use the stipend for health insurance so it may not accomplish the employer’s objective.
  • Employees may not view the money as a formal health benefits program, which means that if the business decides to cut this “health benefit,” employees may view it as a cut in pay.

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

Best Practices for Health Insurance Stipends

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

  • Do not 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 doing so. See IRS notice 2013-54 for details.
  • Do treat the stipend as taxable income.
  • Continuously communicate to employees that the stipend is intended as a health benefit. This way, employees will not simply consider the stipend as wages.

Health reimbursement arrangements (HRAs) are a full benefit

As mentioned stipends are subject to both payroll and income taxes, which means employer dollars don’t go as far as they could.

HRAs are a more effective solution than stipends because:

  1. They are tax free. Reimbursements are free of payroll taxes for both employer and employee. They are also free of income taxes, as long as the employee has Minimum Essential Coverage (MEC).
  2. 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.
  3. They can be easy to implement. Companies like PeopleKeep can set you up with an HRA in less than an hour that you can manage in minutes per month. You can rest easy knowing you have fully compliant legal documentation, intuitive software to facilitate expense submission and reimbursement, and experts to review all expense documentation to ensure you are only reimbursing employees for eligible expenses.
  4. They help you attract and retain top talent. HRAs allow small and medium sized organizations to offer a quality health benefit without breaking their budget. Read how Summit Dental Group used an HRA to improve employee retention.

Related: Health Insurance Stipend vs. A Reimbursement Plan - Which is Better?

Conclusion

Health insurance stipends are one way to help employees with the cost of their health insurance. When evaluating this approach, weigh the pros and cons, understand best practices, and consider setting up a tax-free HRA to save money.

Learn more about what HRAs are and how they can help your organization.

What questions do you have about health insurance stipends? Leave a comment below and we’ll answer them for you.

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