Defined contribution health plans
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Looking for a more cost-effective and flexible way to offer health benefits to your employees?
Rather than paying a portion of the costs to provide a traditional group health benefit like group health insurance, employers can control their costs by establishing a defined contribution health plan. You can implement these plans through the use of pre-funded accounts like a health savings account (HSA) or through a health reimbursement arrangement (HRA).
Topics covered in this guide include:
- What is a defined contribution health plan?
- How defined contribution health plans work
- The benefits of a defined contribution health plan
- HRAs vs. HSAs
- A comparison of HRAs
- Why defined contribution plans work
- Design requirements for defined contribution plans
- Compliance requirements for defined contribution plans
- How to manage a defined contribution plan
- Defined contribution FAQs
What is a defined contribution health plan?
The general concept of a defined contribution health plan is that an organization gives each employee a fixed dollar amount (known as a "defined contribution") that their employees can choose how to spend.
Typically, employees are allowed to use their defined contribution allowance toward qualified out-of-pocket health expenses like insurance premiums, medication, and preventative care.
They allow employees to be more involved in their health benefit plans, which is especially important given the rise in healthcare consumerism. With a defined contribution health plan, employees can select the individual health insurance plan of their choice and make payments toward healthcare costs out of their own finances upfront. Then, they can get reimbursed from the funds in their annual or monthly benefit allowance.
How defined contribution health plans work
Defined contribution health plans offer an alternative to "defined benefit" group health insurance. Just as employers have moved away from defined retirement benefits like pensions and toward defined contribution retirement plans such as 401(k)s, many are applying this model to their health benefits programs.
The general strategy of a defined contribution health plan is just three simple steps:
- Step 1: The employer offers each employee a fixed monthly dollar amount to spend on qualified medical expenses. This might be a direct contribution to a savings account or an allowance the employer agrees to reimburse employees for after the expenses are incurred.
- Step 2: Employees select and purchase the individual or family health plan that works best for their individual needs. Employees may purchase their own policy directly from any health insurance company, through a broker, private exchanges, or the HealthCare.gov or state Health Insurance Marketplaces. Depending on the employee's plan documents, employees may also purchase several other health care products and services that qualify as eligible expenses.
- Step 3: The employer reimburses employees up to the amount of their defined contribution allowance, or the employee uses the funds in their HSA.
Defined contribution health plans by themselves are not health insurance plans. Defined contribution plans give the employer control of employee benefits while still giving employees a choice.
Do defined contribution plans work for ALEs?
If you're an applicable large employer (ALE) with 50 or more full-time equivalent employees (FTEs), you're required by the Affordable Care Act's (ACA) employer mandate to provide health insurance to all of your full-time workers who work more than 30 hours per week.
You can meet the mandate's requirements if you offer an individual coverage HRA (ICHRA). An ICHRA requires employees to purchase individual insurance policies that meet minimum essential coverage (MEC), allowing your organization to satisfy the law.
In addition, it's important to note that employers must offer an affordable allowance to comply with the mandate.
See the individual coverage HRA (ICHRA) in action with our free demo video
The benefits of a defined contribution health plan
It's a self-funded health or savings plan
A common reason employers use a defined contribution health plan such as an HSA or HRA is they are self-funded health plans, which gives employers and employees greater control over exactly how much they spend on healthcare benefits. With a fully-insured health plan, the costs are controlled by insurance companies.
It's a tax-free health benefit
Many employers who don't qualify for group health plans, or simply can't afford them, often resort to offering taxable wage increases. This subjects your organization to additional federal income, Medicare, and Social Security payroll taxes.
A defined contribution health plan is free of payroll taxes for both the employer and employee. As long as the employee uses their allowance to purchase a policy with MEC, it's also free of income taxes. This makes employers' benefit dollars stretch further.
It can work as a standalone benefit or alongside a group plan
On top of these benefits, a defined contribution health plan doesn't have to be a standalone benefit. Employers who are already offering a group health plan can offer a group coverage HRA (GCHRA), also known as an integrated HRA, alongside the group plan. There are a few ways to accomplish this, depending on your needs.
HRAs vs. HSAs
While HRAs and HSAs are both defined contribution plans, they work differently. HRAs are offered independently of group health insurance plans (except an integrated HRA), while HSAs require HSA-eligible plans such as high deductible health plans (HDHPs).
Additionally, an HRA is owned and managed by the employer, as they're an arrangement instead of an account. An HSA, however, is owned by the employee, meaning they can take their contributions and your employer contributions with them when they leave your organization. With an HRA, the unused funds stay with you.
Comparing the different types of HRAs
PeopleKeep offers Section 105 Plans that meet nearly every employer's need, including benefits for for-profit and nonprofit employees.
We offer three popular types of HRAs, including:
Choosing the one that is right for you may seem complicated, so we've broken it all down with our HRA comparison chart.
|QSEHRA||ICHRA||Group Coverage HRA|
|Business size restrictions||Limited to businesses with fewer than 50 FTE employees||None||None|
|Allowance amount restrictions||Limited to $5,450 for self-only employees and $11,050 for employees with a family in 2022. Businesses cannot give employees different allowance amounts based on criteria other than family status.||None||No minimum or maximum contribution requirements. Businesses can give different employees different allowance amounts based on job-based criteria.|
|Group health policy requirements||A QSEHRA can’t be offered with a group health policy||Can be offered with a group health policy, but employees cannot have a choice between the group policy and the HRA.||Must be offered with a group health policy|
|Individual health policies permitted||Yes||Yes; in fact, they're required to participate in the ICHRA.||No|
|Premium tax credit coordination requirements||Employees must reduce their premium tax credit by the amount of their HRA allowance.||Employees cannot collect premium tax credits and participate in the ICHRA. However, if the ICHRA allowance is considered unaffordable, employees may waive the HRA and collect the credits.||N/A. These HRAs can’t reimburse employees for individual premiums.|
|Medical expenses available for reimbursement||Any or all items listed in IRS Publication 502||Any or all items listed in IRS Publication 502||Any or all items listed in IRS Publication 502 except for individual insurance premiums|
|Employee eligibility guidelines||All full-time employees are eligible. Businesses can decide on part-time employee eligibility.||Businesses can decide on eligibility based on 11 different employee classes.||None|
Why defined contribution health plans work
Defined contribution health plans work for employers and employees because:
- Individual health insurance costs 20% - 60% less than comparable group health coverage. The employer's healthcare dollars go further.
- Contributions are tax-deductible to the employer, and employees receive reimbursements tax-free.
- The employer gains fiscal control and predictability over their health benefits budget.
- There are no minimum or maximum contribution amounts—depending on the HRA offered—and no minimum participation requirements.
- Employees have control over their individual health insurance plans, enabling them to make consumer-driven choices.
Depending on the plan and their income level, employees may have access to the premium tax credit subsidies through the insurance marketplace or their state exchange.
Design requirements for defined contribution health plans
There are two key questions to ask when designing your health plan.
When will the plan year start?
Your organization can decide when your defined contribution plan will start. For many organizations, this is at the beginning of the year, but it doesn't have to be.
How much will you provide each month?
You probably already have a budget in mind for health benefits. Within this budget, how will you divide up employees' monthly allowances? If you offer an HRA, you will come up with a monthly allowance that employees can use toward health expenses.
With an ICHRA, you can provide the same monthly allowance amount to all employees or different monthly allowances to different types/classes of employees. The employee classes must be based on bonafide job-based criteria such as job title, location, etc.
An ICHRA also allows you to provide an ICHRA to only certain employee classes, such as part-time or hourly employees, while still offering a group health insurance policy to a different employee class, such as salaried employees.
You can also vary the allowance amounts by family status on any HRA.
Compliance requirements for defined contribution health plans
Section 105 Plans are considered group health plans. As such, they must comply with IRS, HIPAA, COBRA, ERISA, and ACA regulations.
This section details compliance requirements that may impact your health benefit options.
Internal Revenue Service (IRS) requirements
The IRS has many rules that organizations must satisfy for your benefits, such as HRAs, to be tax-advantaged.
The IRS requires the following:
- Plan documents: The IRS requires that written plan documents be established and maintained. Plan documents define what expenses are eligible for reimbursement, the amount of employer contribution, and other required details about the reimbursement plan.
- Documentation: The IRS requires that employees submit proper documentation verifying their claim for reimbursement and that supporting documentation is saved on file for ten years.
Non-discrimination: Defined contribution health plans must comply with nondiscrimination rules. The rules state the plan must not discriminate in favor of highly compensated individuals (HCIs) with respect to eligibility to participate in the plan or benefits provided under the plan.
Health Insurance Portability and Accountability Act (HIPAA)
Defined contribution health plans are governed by HIPAA rules. To administer a plan correctly, the entity processing employee reimbursement claims receives protected health information (PHI) that is required to be held confidentially.
Consolidated Omnibus Budget Reconciliation Act (COBRA)
For plans with 20 or more participants, employers must give terminated employees the option to continue their participation in the plan for a period after termination and may charge an employee up to 102% of the value of their allowance if COBRA is elected.
Employee Retirement Income Security Act (ERISA)
ERISA rules apply to all health benefits, including traditional group health insurance and HRAs.
ERISA requires every welfare plan to have a summary plan description (SPD) and to furnish copies to each participant.
The U.S. federal government also has specific regulations employers must comply with in order to reimburse employees for individual health insurance premiums without triggering ERISA plan status for the individual health insurance policies. For example, the employer must not endorse specific individual health insurance policies or pay directly for them.
Affordable Care Act (ACA) rules
There are a variety of ACA regulations that apply to defined contribution plans.
ACA rules to know include:
- Annual limit compliance: Section 2711 of the Public Health Services (PHS) Act, as added by the ACA, provides that no annual or lifetime limits may be placed on essential health benefits (EHB). The act provides that annual limits and lifetime limits may be placed on benefits that are not EHB, such as health insurance premiums.
- Preventive care compliance: Section 2713 of the PHS Act requires group health plans (including defined contribution plans) to cover basic preventive health services without cost-sharing.
- 90-day waiting period compliance: The ACA prohibits waiting periods over 90 days for eligible employees.
- Internal and external claims appeal process: The ACA added new requirements to the internal and external appeal process, including how and when procedures are communicated to plan participants.
- Dependent coverage for adult children up to age 26: Section 2714 of the PHS Act provides that group health plans (including defined contribution plans) that make available dependent coverage for children must make such coverage available for children until 26 years of age.
- Uniform explanation of coverage and definitions: The ACA requires that group health plans, participants, and beneficiaries receive a standardized summary of benefits and coverage (SBC) and a set of uniform definitions (uniform glossary), both of which must conform to requirements outlined in the ACA and existing regulations.
- PCORI fee: The ACA includes a research fee that individual health insurance plan sponsors must pay on an annual basis annually via IRS Form 720.
- 60-day notice of material modification: The ACA requires employers to provide 60 days of advance notice to participants when making material modifications to their group health plan.
How do you manage a defined contribution health plan?
If your organization decides to offer an HRA to your employees, you have three options:
- Self-administration of your health benefits
- Use a third-party administrator to ensure compliance
- Use a software solution
If you decide to manage your defined contribution health plan on your own, you take on all of the various responsibilities and liabilities for those benefits, including compliance.
Many organizations choose a third-party service or software solution to avoid this risk to ensure proper compliance.
With PeopleKeep, you can keep complete ownership of your HRAs while taking advantage of our award-winning customer support.
Frequently asked questions about defined contribution
Can you offer health insurance to only certain employees?
Depending on the plan you choose to offer, you can make the health benefit available to certain classes of employees only. For example, with an HRA, you can offer different allowances to employees in different job-based groups. To learn more, see our article on employee eligibility.
What is the difference between an HRA and an HSA?
The most significant difference between HRAs and HSAs is that the business owns the HRA while the employee owns the HSA. In addition, an HRA is a reimbursement arrangement between an employer and employee, whereas an HSA is a savings account owned by the employee. To learn more, see our article on HRAs vs. HSAs.
Can I have an HRA and an HSA at the same time?
Yes! Unique rules apply to users, especially regarding what items are available for reimbursement when an HSA is in place. To learn more, read our article on using HRAs and HSAs.
What can an HRA reimburse?
HRAs can reimburse many healthcare products and services, including the following types of insurance premiums, provided they were not already paid with pre-tax dollars:
- Major medical individual health insurance premiums
- Dental care and vision care premiums
- Qualified ancillary premiums (e.g., accident policies)
- Medicare Part A or B, Medicare HMO, and employer-sponsored health insurance premiums
- Medicare Advantage and Supplement premiums
- COBRA premiums.
To learn more, read our article on what expenses an HRA can reimburse.
Looking to add a defined contribution health plan to your benefits package?
Speak with a PeopleKeep personalized benefits advisor who can help you answer questions, and help you select the right health benefit for your team.