1. Tax-deductible contributions, 
2. Tax-free accumulation of interest and dividends tax-free, and 
3. Tax-free distributions for qualified medical expenses.

Health Reimbursement Arrangements (HRAs) make the most sense for employers who want to provide employee health benefits but have been priced out of traditional group plans.

The best time to offer an HRA is when your client is unable to afford an annual rate increase on a group health insurance plan.

HRAs are 100 percent employer-funded and controlled, and there is no maximum or minimum amount employers may contribute.  Generally, employees cannot take unspent HRA funds with them when they changes jobs.

In addition, HRAs allow reimbursement of an employee's individual insurance premiums, making them a capable alternative to group health insurance plans for many businesses.

Prior to World War II, most Americans paid for their own medical care, either directly to their chosen provider or through Blue Cross nonprofit health insurance entities which were created by hospitals to offer individuals guaranteed service in return for a fixed fee. Back then, health insurance was really insurance—providing payment only for major items like hospitalizations that people could not afford to pay for themselves.

Many employees purchased their own individual or family health insurance policies, sometimes called personal health insurance policies, just like they do today with homeowners, auto, and life insurance.

During World War II, government leaders and economists were greatly concerned with potential postwar inflation. They had seen firsthand what happened in Germany after World War I, and blamed Hitler’s rise to power on Germany’s postwar inflation and economic ruin.

To avoid inflation, the U.S. Congress and President Roosevelt instituted wage and price controls during World War II and were determined to maintain them after the war.

In 1945, in order to politically grant a concession to labor without appearing to violate wage and price controls, the federal government exempted employer-paid health benefits from wage controls and income taxation—in effect allowing off-the-books raises for employees in the form of nontaxable health benefits.

This was economically equivalent to giving employees cash for their medical expenses, cash that employers and employees legally didn’t have to report to the IRS. This unreported off-the-books compensation in the form of health benefits created an enormous tax advantage for employer-sponsored group health benefits over personal health insurance policies and incidental medical expenses purchased by employees with their own after-tax dollars. Employers received a 100% federal, state, and city tax deduction for the cost, and health benefits received by employees were exempt from individual federal, state and city taxation.

This created an up to 2-for-1 tax advantage (depending on the income tax bracket of the employee) for employer health benefits provided by employers versus health benefits, including personal health insurance policies, purchased by employees themselves.

Today, most employers offer their employees group health benefits and typically pay 60%-100% of the cost for employees who participate. Group employer health care costs (and group insurance premiums) have been increasing the past five years at 3-4 times the rate of general inflation.

In response to the rising costs of group coverage, employers have been reducing health benefits, increasing the employee (and especially dependent) cost to participate, or even cutting out health benefits entirely. An increasingly popular way to counteract the rising costs of group coverage and to maintain employee benefits is with tax-advantaged benefit programs such as HRAs, FSAs, POPs, and HSA’s.

There are four basic types of accounts and arrangements that companies use to provide tax-advantaged medical expense and insurance premium reimbursement to employees.

Company Funded Arrangements

Health Reimbursement Arrangements (HRAs)

Health Reimbursement Arrangements are tax-advantaged arrangements (not accounts) that employees can use to receive reimbursement for qualified medical expenses, including health insurance premiums. An HRA can supplement a group policy or provide employer funds for an individual health policy. All employees, former employees, and retirees qualify to have an HRA.  HRAs must be 100% funded by employers.


Employee Funded or Owned Accounts

Flexible Spending Accounts (FSAs)

Flexible Spending Accounts are tax-advantaged arrangements where employees convert pre-tax wages into a fixed annual fund to pay for out-of-pocket medical expenses. FSA funds cannot pay for health insurance premiums. All employees qualify to have an FSA. FSAs are generally 100% funded by employees, although employers are allowed to offer incentive Flex Credits as FSA contributions.

Premium Only Plans (POPs)

Premium only Plans are effectively an FSA for individual or family health insurance premiums, as allowed under new IRS regulations effective 1/1/09. Employers can either reimburse employees for individual health insurance policy premiums or pay such premiums directly to insurance carriers. All employees qualify to have a PSA.

Health Savings Accounts (HSAs)

Health Savings Accounts are tax-advantaged consumer savings accounts similar to an IRA or 401k that consumers can use to pay for qualified medical expenses. HSAs are supplements to health insurance since HSA funds cannot generally pay for health insurance premiums. Only employees who obtain HSA-qualified high deductible health insurance from an employer’s group plan or from a individual health policy qualify to have an HSA. HSAs can be funded by employers, employees, or third parties.

Employers are allowed to use Health Reimbursement Arrangements (HRAs) to reimburse employees tax free for individual health insurance premiums, similar to the way employers contribute on a tax free basis to group premiums. This has been clarified with the release of numerous U.S. Treasury and State publications spelling out how employers can use HRAs for tax-free reimbursement of the premiums paid for personal health insurance policies. See "Insurance Premiums" in IRS Publication 502. Also see IRS Publication 969.

The Department of Health and Human Services (www.hhs.gov) released new information today on how to access the new Pre-Existing Condition Insurance Plan (PCIP) established by The Affordable Care Act. The new plan makes health coverage available to individuals with pre-existing conditions that have been uninsured for at least 6 months.