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Small Business Employee Benefits and HR Blog

What are the Pros and Cons of Health Insurance Stipends?

Many small businesses do not offer formal health benefits, but they want to help with employees’ health insurance costs. So, the business gives employees a taxable raise or bonus to use toward health care.

Is giving employees a lump sum for health insurance still allowed? Yes, as long as the business does not require employees to prove they purchased health insurance. Are there pros and cons to this approach? Absolutely.

In this article, we’ll look at the pros and cons of giving employees a taxable health insurance stipend, outline best practices, and discuss a tax-free way to help employees with health insurance.

Pros and Cons of Health Insurance StipendsPros of a Health Insurance Stipend

With a health insurance stipend, all similarly situated employees receive a fixed, taxable stipend to purchase individual health insurance, whether or not they actually purchase health insurance. The employee's monthly contributions are typically added to his or her paycheck.

Pros of a health insurance stipend:

  • Not a group health plan, so no compliance considerations.

  • Very simple and easy administration (automatic payroll additions).

Cons of a Health Insurance Stipend

A health insurance stipend is an easy, no-strings-attached way to help employees with their health insurance. There are, however, some drawbacks to consider.

Cons of a health insurance stipend:

  • Business is required to pay payroll tax on reimbursements (7.65 percent).

  • Employees must claim amounts received as income (20 to 40 percent).

  • Employees receive money regardless if they use it toward health insurance.

  • Employees may not view the money as a formal health benefits program. Likewise, it is hard to “take back” the stipend if the business changes course.

Best Practices for Health Insurance Stipends

When offering employees a health insurance stipend, here are three best practices to consider:

  • Do not ask employees to show proof of health insurance. Direct payment or direct reimbursement for health insurance is considered an “Employer Payment Plan” and the business could face penalties for doing so.

  • Treat the stipend as taxable income.

  • Continuously communicate the health benefit to employees. This way, employees will view it as a health benefit and not lose track of what the business is providing.

A Tax-Free Option

Many businesses who consider, or start with, a health insurance stipend end up formalizing the arrangement. Why? Cost savings. How? Set up a formal, tax-advantaged Health Reimbursement Arrangment (HRA).

An HRA is allowed under current federal rules and regulations, as long as the business uses a compliant plan such as the Small Business HRA.

As an added bonus, the business is offering formal health benefits that will help recruit and retain the best staff.

Related: Health Insurance Stipend vs. A Reimbursement Plan - Which is Better?

Conclusion

Health insurance stipends are one way to help employees with the cost of their health insurance. When evaluating this approach, weigh the pros and cons, understand best practices, and consider setting up a tax-free HRA to save money.

What questions do you have about health insurance stipends? Leave a comment below. We’d be happy to help answer them.

The small business HRA is 100% compliant.

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