Health Reimbursement Arrangements (HRAs)

If you're like most employers, your primary concern relating to the provision of employee benefits is the high cost of medical insurance. While you want to provide your employees comprehensive major medical protection, it needs to be affordable. Health Reimbursement Arrangements provide a strategy that enables you to achieve that goal.

Authorized under Section 105 of the Internal Revenue Code, a Health Reimbursement Arrangement (HRA), also known as a Health Reimbursement Account, is a type of self-funded, tax-favored program that may be offered either in conjunction with a health plan, or as a standalone plan to reimburse qualified out-of-pocket medical expenses.

Although HRAs can be established in conjunction with any type of health plan, most often they are paired with a High Deductible Health Plan (HDHP). This pairing allows an employer to fund employees' individual Health Reimbursement Accounts using premium savings realized by switching from a low deductible health plan to a more economical high deductible plan.

Any type of an employer of any size can offer a HRA to its employees. However, HRAs are subject to non-discrimination testing under Section 105(h) of the Internal Revenue Code. These rules prohibit discrimination in favor of highly compensated individuals as to eligibility to participate and the benefits provided by the HRA. In general, 2% or more owners of an S-Corporation, partners in a partnership or LLC and sole proprietors are not eligible to participate in their company's plan on a tax-favored basis.

Pairing a high deductible health plan with an HRA has a number of advantages for an employer, including the following:

• You reduce your health insurance premium when you replace your low deductible health plan with a high deductible plan.
• If your employees incur fewer medical expenses than the amount you deposit in their respective HRA, your savings can be even greater.
• You have an opportunity to reduce costs at renewal, since employees will have an incentive to make more informed decisions about their health care.
• Reimbursements are tax deductible.
• You do not need to pre-fund your HRA account. Reimbursements may be made from your business’ general account when medical expenses are incurred, which allows for greater control of cash flow.
• If an employee's employment is terminated, you can retain ownership of the funds.

You have a great amount of flexibility in designing your HRA. You can specify the terms of your HRA, including the following:

• The maximum annual reimbursement.
• Who pays deductible expenses first: your employees or you, through your HRA reimbursements.
• Whether unused funds can be rolled over to the next year, and if so, the amount that can be rolled over.
• What expenses will be covered by the HRA. For example, you may elect to allow all IRS qualified medical expenses to be paid through the HRA, or you may limit or restrict what expenses may be reimbursed. And if you wanted to encourage employees to seek preventive care, you might stipulate that a portion of the HRA is forfeited if not used for

Pairing a high deductible health plan with an HRA has a number of advantages for the employee, including the following:

• Employees are protected against catastrophic medical costs.
• HRAs are employer-funded and depending upon the plan design, the employer may pay for benefits first.
• Employees receive reimbursements tax-free.
• Employees become more involved in their own health care and make more informed spending decisions.

Employees can save money when you move to a higher deductible plan with an HRA. Here's how:

• If employees currently pay for a portion of their premium, you can reduce the amount they pay.
• If you provide "Employee-Only" coverage, employees paying for their family will save on the dependent premium.
• If a catastrophic event does occur, an employee’s portion of total claim cost could be less with an HRA plan, especially if you select a high deductible health plan that pays 100% of covered benefits once the deductible has been met.
• Funds remaining in the HRA at year-end can be rolled over from year to year if permitted in the plan design.
• Employees can build up a significant account balance to be used for future medical needs if the plan design permits rollovers.

HRA plan designs are virtually limitless, but below are examples of frequently used plan designs. These examples are based on pairing an HRA with a High Deductible Health Plan that has a $2,000 deductible with 100% coinsurance.

Design 1 – Employer Pays First

• Employer reimburses first $1,000 from HRA
• Employee pays the next $1,000
• Health plan pays remaining covered benefits

Benefits: Provides first-dollar coverage for employees. Can help assure a smooth transition to a high deductible plan.

Design 2 – Employee Pays First

• Employee pays first $1,000 of deductible
• Employer reimburses next $1,000 from HRA 
• Health plan pays remaining covered benefits

Benefits: Employer saves the most money. Encourages informed and responsible use of health care services.

Design 3 – Split Deductible

• Employer and employee split all to the deductible costs
• Health plan pays remaining covered benefits

Benefit: Offers a “middle ground” plan in which expenses are shared from the outset.

Design 4 – Divided Deductible

• Employee pays first $500 of deductible
• Employer reimburses next $1,000 from HRA
• Employee pays next $500 of deductible
• Health plan pays remaining covered benefits

Benefit: Employee deductible is divided in two. The initial employee portion can mirror the group’s current plan deductible.

These are the general rules relating to the funding of an HRA:

• HRAs must be funded solely by the employer. The employer may not fund the HRA through a salary reduction election.
• There are no specific dollar limitations on the amount an employer may credit to an HRA.
• Employers may fund HRAs with annual lump sums or on a per pay period basis.
• Employer’s may restrict reimbursements to current account balances

Although -- if paired with a health plan -- employees may be asked to contribute to the cost of their health plan premium, no portion of the HRA can be funded by the employee. The HRA may only be funded by the employer.

Funds must be used for qualified medical expenses permitted under Section 213(d) of the Internal Revenue Code, although the employer can establish more restrictive limits for the use of HRA funds. To view a partial list of qualified medical expenses, click here.

In order for employers to implement an HRA they must have a written plan document in place. In addition, there is a requirement to provide each employee with a Summary Plan Description (SPD). An SPD is a summary of the Plan Document. Considered a self-insured health plan, the employer must annually pass non-discrimination testing to remain in compliance with Plan requirements. As a self-insured Health Plan both COBRA and HIPAA apply.

You can administer the HRA yourself, but most employers prefer to have a Third Party Administrator (TPA) prepare the plan documents and administer claims to avoid being consumed with paperwork, HIPPA privacy concerns and medical claims processing.

In their most recent guidance, the IRS permits unused funds to be carried over from year to year. However, carryovers are not required, and many employers elect not to allow them. Health Reimbursement Accounts generally remain with the originating employer and do not follow an employee to new employment, although balances may be used after termination of employment at the discretion of the employer.

Employers qualify for preferential tax treatment of funds contributed to a Health Reimbursement Account in the same way that they qualify for tax advantages by funding an insurance plan. In short an employer can deduct the cost of both an insurance plan and a Health Reimbursement Account as a business expense. And, as is true of qualified Health Savings Accounts and Flexible Spending Accounts, reimbursement of medical care expenses of an employee and the employee’s spouse and dependents are generally excludable from the employee’s gross income.

If an HRA is provided in addition to a Flexible Spending Account (FSA) special rules apply to the ordering of payments. Absent a specific ordering rule in the HRA document, the HRA funds must be used first if the FSA covers a medical expense that also is covered by the HRA. And, of course, employees cannot be reimbursed for the same medical expense by both an HRA and an FSA.