Health Reimbursement Arrangements

A health reimbursement arrangement (HRA) is an employer-sponsored health-care option that allows employees to pay for medical costs using a pool of employer-provided funds. health reimbursement arrangements reimburse employees for qualified medical expenses they've incurred, up to a maximum amount per coverage period.

HRAs are typically established to meet the needs of both employers and employees. Employers may establish health reimbursement arrangements to provide better health-care coverage for employees or to contain health-care costs. In some cases, health reimbursement arrangements serve as primary health insurance programs. Most commonly, employers offer health reimbursement arrangements in conjunction with high-deductible medical or accident insurance plans. Employees who pay deductibles or other costs not covered by the high-deductible plan are reimbursed for these costs from their employer's health reimbursement arrangement. In both cases, the employer saves money on health insurance premiums.

What are the advantages and disadvantages of health reimbursement arrangements?

• Employers can make compensation packages more attractive by offering health reimbursement arrangements.
• Employers can contain health-care costs by offering health reimbursement arrangements in conjunction with high-deductible major medical plans.
• Employers offering health reimbursement arrangements must pay administrative costs to make sure they comply with complex legal and tax requirements.
• Employers must pay the full cost of funding the plan.

• Health reimbursement arrangements are funded solely by employers. An health reimbursement arrangement cannot be funded by a salary-reduction election either directly or indirectly through a cafeteria plan.
• Health reimbursement arrangements can be used to pay for health insurance premiums (e.g., major medical plans), as well as services typically not covered by health plans (e.g., eyeglasses or alternative medicines).
• Health reimbursement arrangement reimbursements are generally excludable from the employee's gross income, provided the reimbursements are for qualified medical expenses as defined by the tax code.
• Health reimbursement arrangements can allow participants to carry over any unused amounts into the next year.
• Health reimbursement arrangements may continue to reimburse former or retired employees for medical expenses.
• Employees will face increased paperwork, since they must submit receipts or other documentation in order to be reimbursed for qualified health-care expenses.
• Employees may shoulder more of the cost of health care with an health reimbursement arrangement than they would with a traditional group health plan.

Although health reimbursement arrangements and flexible spending accounts (FSAs) share certain attributes, they are significantly different. Flexible spending accounts require employees to make pretax contributions to an account, while health reimbursement arrangements prohibit this; only employers can make contributions to an account. In fact, if it appears that an employee's salary has been reduced to offset the cost of the health reimbursement arrangement, the status of the arrangement could be jeopardized. Health reimbursement arrangementfunds can only be used to reimburse employees for qualified medical expenses, whereas flexible spending accounts can be used for benefits other than health care. Another important difference is that flexible spending accounts renew annually with a "use-it-or-lose-it" clause. If an employee has a remaining balance, those funds are given to the employer to pay administrative costs associated with the plan. health reimbursement arrangements, however, allow employees to carry over unused funds from year to year.

Example 1: If Jack elects to contribute $2,000 to a flexible spending account this year, and his reimbursable medical expenses for this year add up to only $1,600, he will lose the remaining $400 in the account. But a health reimbursement arrangement works this way: In 2004, his employer sets the health reimbursement arrangement maximum reimbursement amount at $1,000. If Jack incurs only $600 of qualified medical expenses, the $400 balance remains in his account. In 2005, if his employer continues the reimbursement maximum at $1,000, Jack will have $1,400 in his health reimbursement arrangement.

An employer may offer both a health FSA and a health reimbursement arrangement. But if coverage is provided under a health reimbursement arrangement and a health flexible spending account for the same health-care expenses, health reimbursement arrangement funds must be exhausted before reimbursements can be made from the flexible spending account, unless the health reimbursement arrangement plan document specifies that coverage under the health reimbursement arrangement is available only after expenses exceeding the dollar amount of the flexible spending account have been paid.

Health Savings Accounts which replaced Archer medical savings accounts in 2004, operate like health reimbursement arrangements. However, Archer MSAs were only available to individuals who fall into one of two categories:

1. Employees (or their spouses) of companies that employ 50 or fewer people and maintain a high-deductible health plan
2. Self-employed individuals (or their spouses) who also have a high-deductible health insurance plan

The Archer MSA program ended on December 31, 2003, replaced by Health Savings Accounts which are more lenient in their requirements and more generous in the benefits.

If a health reimbursement arrangement is considered an employer-sponsored accident or health plan under IRS rules, reimbursements for health-care expenses (including health insurance premiums) are generally excludable from the employee's gross income. But to be considered excludable, the reimbursements must be for health-care expenses incurred by individuals covered by the health reimbursement arrangement. These individuals may include:

• Current employees
• Former employees (including retired employees), whether or not they elect COBRA continuation coverage
• Spouses and dependents of employees and former employees
• Spouses and dependents of deceased employees

Health reimbursement arrangements may only reimburse qualified expenses that are substantiated and that occur after the date an employee first enrolled in the health reimbursement arrangement. Health reimbursement arrangements must comply with other complex IRS regulations. For more information, consult a tax advisor or the IRS website.

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