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Small Business Employee Benefits and HR Blog

FAQ - Can I Offer a Health Insurance Stipend to Employees?

A common question among small business owners is whether they can offer FAQ - Can I Offer a Health Insurance Stipend to Employees?employees a stipend to help pay for the cost of individual health insurance. Business owners also wonder if a health insurance stipend is a better choice compared to other options, such as a Health Reimbursement Arrangement (HRA) like the Small Business HRA.

The short answer is yes—companies can provide workers with a health insurance stipend. However, business owners should be aware of the tax implications of a health insurance stipend versus a tax-free reimbursement plan like the Small Business HRA.

Offering a Health Insurance Stipend

One way for small businesses to help workers cover health costs is to offer a health insurance stipend, which is simply extra money in an employee’s paycheck. This stipend is the equivalent of simply grossing up wages—it is a flat amount given to all employees, which they can spend however they choose. While the company may ask employees to spend the money on health insurance, it cannot require employees to do so. It also cannot require employees to provide proof that they purchased a health insurance policy.

One of the chief downsides to this approach is that the money is treated as taxable income for the employee. Businesses that provide a health insurance stipend must also pay payroll taxes on reimbursements.

Tax-Free Reimbursement Arrangements

Health insurance stipends may be straightforward to set up, but the fact that they’re taxable is an understandable downside for many businesses and their employees. More than that, employees may not always associate the stipend with health benefits, which can defeat the purpose of offering the stipend in lieu of a group plan or other arrangement.

This is why many employers opt for a tax-free option, such as a health reimbursement arrangement. For small businesses—defined by IRS rules as those with fewer than 50 employees—the Small Business HRA offers the flexibility of a health insurance stipend without the tax consequences. And unlike a stipend, an HRA reimburses employees only for qualified individual health insurance and medical expenses.

Setting up a Small Business HRA is quite simple:

1. The business establishes formal written Small Business HRA plan documents.

2. The business determines the amounts available to each employee monthly for reimbursement of qualified health insurance expenses. The business can offer different allowance amounts to different employees based on family status (self-only or employees with a family).

3. Employees submit health insurance expenses and, once approved, the business reimburses the employees up to the available amounts.

To ensure compliance and easy administration, nearly all businesses use a Small Business HRA software provider to set up and administer the plan.

Why Health Insurance Stipends and Reimbursement Plans Are Gaining in Popularity

This type of approach - providing employees with a taxable stipend or tax-free reimbursement plan instead of a specific health insurance plan - is gaining popularity in the US, especially with smaller businesses and nonprofits.

A driving force is cost. In the past, small businesses and nonprofits have relied on group health insurance to offer employee health benefits. However, continual increases in healthcare costs have adversely impacted most businesses’ ability to provide health benefits in the traditional way. Small businesses have been particularly hurt, and many have dropped group health insurance plans because they have become too expensive.

On top of cost, employers and employees find this type of arrangement attractive because:

  • Employees choose the health plan that best fits their family (rather than a one-size fits all plan chosen by the business). Employees can shop for their health plan through the new state health insurance marketplaces, through a health insurance broker, or from any insurance company.

  • Businesses fix their costs by giving employees a monthly allowance (rather than needing to contribute a certain amount to the group health insurance premiums).

  • Once implemented, it takes less than 5 minutes per month to administer online (much less time and administrative commitment compared to a group health insurance plan).

Conclusion

A health insurance stipend is one option among many available to employers looking for alternatives to expensive group health plans. Before choosing a stipend, business owners should familiarize themselves with the tax implications associated with stipends and consider other options, such as the Small Business HRA.

Editor's Note: This article has been updated to reflect new benefit options like the Small Business HRA. The article was originally published on October 21, 2013.

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Has your business made the switch from a health insurance stipend? Why? Let us know in the comments.

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