When it comes to employer-sponsored health benefits, few options offer the flexibility and tax advantages of a Health Reimbursement Arrangement (HRA). For businesses aiming to support their employees’ healthcare needs while controlling costs, an HRA can be a powerful tool. However, in order to be valid and legally compliant, a Health Reimbursement Arrangement must be established according to specific rules and guidelines.
This article explores what HRAs are, why formal establishment is crucial, how to set them up properly, and the benefits they offer both employers and employees. Whether you’re a small business owner, an HR professional, or an employee looking to understand your benefits, this guide provides a clear and thorough explanation.
Table of Contents
What Is a Health Reimbursement Arrangement (HRA)?
A Health Reimbursement Arrangement is an employer-funded account that reimburses employees for qualified medical expenses and, in some cases, insurance premiums. Unlike Health Savings Accounts (HSAs), HRAs are not owned by the employee and cannot be contributed to by the employee directly.
Key characteristics of HRAs include:
- Funded exclusively by the employer
- Reimbursements are tax-free to employees (if used for qualified expenses)
- Unused funds may or may not roll over, depending on the plan design
- Not portable — employees typically lose access upon leaving the job
There are several types of HRAs, including:
- Standard HRA: For use with group health plans
- Qualified Small Employer HRA (QSEHRA): For businesses with fewer than 50 full-time employees
- Individual Coverage HRA (ICHRA): For businesses of any size, to reimburse employees for individual health insurance plans
- Excepted Benefit HRA: Offers limited reimbursements and can be used even without a group health plan
Each type comes with its own rules, and a Health Reimbursement Arrangement must be established in a specific way to be valid and compliant.
Why Must an HRA Be Officially Established?
An HRA is a formal benefit plan governed by the Internal Revenue Code and regulations under the Affordable Care Act (ACA) and ERISA (Employee Retirement Income Security Act). This means it cannot be casually offered or implied — it must be legally structured, documented, and administered.
The reasons for requiring formal establishment include:
- Legal Compliance: IRS and DOL (Department of Labor) rules demand specific plan documentation and nondiscriminatory application of the benefits.
- Tax Protection: Only properly established HRAs are eligible for tax-free treatment of reimbursements.
- Clarity and Consistency: Employees must receive a clear written notice outlining how the HRA works, their eligibility, and what expenses are covered.
- Avoiding Penalties: An improperly established HRA can lead to costly penalties, especially under ACA compliance rules.
How a Health Reimbursement Arrangement Must Be Established
Creating an HRA involves several formal steps. Here’s a breakdown of the essential components required for establishing an HRA:
1. Drafting a Legal Plan Document
The employer must create a written plan document outlining the terms of the HRA. This includes:
- Eligibility criteria (who qualifies for the HRA)
- The effective date of the plan
- The annual reimbursement limit per employee
- Which expenses are eligible for reimbursement
- Procedures for submitting and processing claims
- Whether unused funds roll over
- Termination conditions (e.g., what happens when an employee leaves)
This document serves as the official foundation of the HRA and must be available for audit and review.
2. Creating a Summary Plan Description (SPD)
The SPD is a simplified version of the plan document provided to employees. It explains the plan in plain language and must be distributed to all eligible participants.
It should include:
- A general description of benefits
- Instructions for filing claims
- Information about appeals and grievance procedures
- Contact information for the plan administrator
3. Providing Employee Notice
Depending on the type of HRA, the employer is required to notify employees in writing before the plan year begins. For example, with an ICHRA, notice must be given at least 90 days before the start of the plan year.
The notice should include:
- The amount available for reimbursement
- Rules about which expenses qualify
- Instructions for accessing reimbursements
- Impact on eligibility for premium tax credits (if applicable)
4. Administering the Plan
Employers must put in place procedures for managing claims and reimbursements, keeping records, and ensuring compliance with HIPAA (if applicable). Employers can either manage this internally or use a third-party administrator (TPA).
Administration must include:
- Verification of receipts and documentation
- Timely payment of reimbursements
- Secure data management
- Annual reporting, if required
Advantages of Establishing an HRA
Establishing an HRA offers significant benefits for both employers and employees.
For Employers:
- Cost Control: Employers set the reimbursement limits, keeping healthcare spending predictable.
- Tax Advantages: Reimbursements are not subject to payroll taxes.
- Customizable Plans: Employers can design HRAs to meet the unique needs of their workforce.
- Attracting Talent: Offering a flexible benefit like an HRA can help recruit and retain employees.
For Employees:
- Tax-Free Reimbursements: Medical expenses reimbursed under an HRA are not included in gross income.
- More Choices: Especially with ICHRAs, employees can choose individual health insurance plans that best suit them.
- No Out-of-Pocket Contributions: Unlike FSAs or HSAs, employees don’t have to fund the HRA themselves.
Potential Pitfalls If Not Properly Established
If a Health Reimbursement Arrangement is not properly established, several issues can arise:
- Loss of Tax Benefits: Reimbursements may be treated as taxable income.
- Penalties for Noncompliance: Employers could face fines under the ACA, including $100 per day per employee.
- Legal Liability: Failure to follow ERISA rules may expose the employer to lawsuits or audits.
- Employee Confusion: Without proper communication and documentation, employees may misunderstand their benefits or lose trust.
Frequently Asked Questions (FAQs)
Q1: Can any employer set up an HRA?
A: Yes, but the type of HRA that can be established depends on the size and structure of the company. For example, QSEHRAs are limited to businesses with fewer than 50 full-time employees, while ICHRA is available to businesses of any size.
Q2: Are HRAs the same as HSAs or FSAs?
A: No. HSAs are employee-owned savings accounts that require enrollment in a high-deductible health plan (HDHP). FSAs are also employee-funded and are typically more limited in rollover options. HRAs are employer-owned and funded, with more flexible design options.
Q3: Do HRA funds roll over each year?
A: It depends on how the HRA is set up. Employers can allow rollover of unused funds or require forfeiture at the end of the year. This decision must be clearly stated in the plan document.
Q4: Can employees contribute to an HRA?
A: No. HRAs are funded solely by the employer. Employees cannot contribute their own money to the arrangement.
Q5: What expenses can be reimbursed under an HRA?
A: Qualified expenses generally include medical costs such as doctor visits, prescriptions, dental care, vision services, and insurance premiums. The plan document must clearly outline the eligible expenses.
Q6: What happens to HRA funds when an employee leaves?
A: Typically, unused HRA funds are forfeited when an employee leaves the company unless otherwise specified in the plan. Some HRAs may offer continuation options under COBRA or a grace period.
Conclusion
In summary, a Health Reimbursement Arrangement must be established with proper legal and administrative steps to ensure it is valid, compliant, and beneficial to both employer and employee. Establishing an HRA goes beyond simply offering to pay for medical expenses — it involves formal documentation, employee communication, and responsible plan management.
When done correctly, an HRA can be a smart and flexible way to support employee health while managing employer costs. But the key to its success lies in understanding and adhering to the rules from the very beginning.
