Comparing Employee Health Benefit Strategies: Stipends, Salary, and HRAs from a Total Rewards Perspective

Introduction

For small business owners and HR professionals, one of the most challenging decisions involves how to provide health benefits to employees. The approach you choose doesn’t just affect your bottom line—it shapes how employees perceive your company’s commitment to their wellbeing.

Over the past decade, traditional group health insurance plans have become increasingly expensive. Many small employers are exploring alternatives: offering health benefit stipends, incorporating benefits into salary, or implementing Health Reimbursement Accounts (HRAs). Each strategy has distinct advantages and drawbacks.

This guide helps you understand the trade-offs between these approaches and how to select a strategy aligned with your company culture, budget, and workforce needs.

Understanding Your Three Primary Options

Option 1: Traditional Group Health Insurance

Before comparing alternatives, it’s worth acknowledging why many employers still choose traditional group plans. A fully insured group health plan provides:

• Predictable costs (usually with 5-10% annual increases)
• Administrative simplicity (the insurer handles most logistics)
• Guaranteed issue coverage regardless of pre-existing conditions
• Employee peace of mind through pooled risk

However, traditional group plans often feel rigid. Small businesses with fewer employees face higher per-capita costs than larger employers. Employees may be forced into a one-size-fits-all plan that doesn’t match their individual needs.

Option 2: Health Benefit Stipends

A health benefit stipend is a fixed monthly amount your company provides to employees specifically for purchasing individual health insurance. The employee uses these funds to buy coverage on the open market (often through Healthcare.gov or state exchanges).

How it works: - You determine a monthly stipend amount (e.g., $300-$600) - Employees use this money to purchase individual plans - Any costs beyond the stipend are the employee’s responsibility - Employees retain ownership and portability of their coverage

Tax implications: This is crucial: direct stipends to employees are not tax-deductible for your business and create taxable income for employees. This changes the math considerably and makes this option less common than it once was.

Option 3: Individual Health Reimbursement Accounts (IHRAs)

An IHRA is an IRS-compliant arrangement where you provide a fixed monthly allowance that employees use to purchase individual health insurance, with tax advantages similar to traditional group plans.

How it works: - You establish an IHRA plan document - You provide a fixed monthly reimbursement budget (e.g., $400-$700) - Employees purchase individual plans and submit proof of coverage - You reimburse them tax-free up to your established limit - Unused funds typically don’t roll over

Tax advantages: - Reimbursements are tax-deductible for your business - Reimbursements are not taxable income to employees - Employees can use pre-tax dollars for out-of-pocket medical costs

Option 4: Salary-Based Approach

Some employers choose to increase base salary instead of offering separate health benefits, allowing employees to purchase coverage independently.

Advantages: - Simplicity in payroll administration - Greater employee autonomy - Salary increases feel more valuable than stipends

Disadvantages: - Employees must actively shop for coverage (many don’t) - No tax advantages for health-specific spending - Higher perceived cost to employer (salary is more expensive than equivalent stipend) - Potential inequity if employees value health benefits differently

Total Rewards Perspective: Beyond the Dollars

When evaluating these options, look beyond per-employee cost. Consider how each option fits your total rewards philosophy—how you communicate the complete value of working at your company.

Employee Perception and Retention

Employees care deeply about health benefits. According to industry research, health insurance ranks in the top three benefits employees value. However, how benefits are offered matters.

Stipend perception: “My employer is giving me money and trusting me to find coverage.” This approach appeals to independent employees who value choice and autonomy. However, it can feel less generous if the amount doesn’t cover quality plans in your area.

IHRA perception: “My employer set aside money specifically for my health insurance.” IHRAs feel more paternalistic—the employer is clearly earmarking funds for health protection. Many employees appreciate this clarity.

Salary approach: “I got a raise.” Most employees prefer cash they control, but they may undervalue health protection until they need it.

Administrative Burden

• Traditional group plan: Moderate burden (enrollment administration, claims questions, compliance)
• Stipends: Low burden (you simply pay the stipend; employees handle everything else)
• IHRAs: Moderate burden (you must maintain plan documentation, track reimbursements, ensure compliance)
• Salary approach: Minimal burden (standard payroll)

Compliance and Legal Considerations

Critical note: Health benefit stipends outside an IHRA framework create significant compliance risks. The IRS and Department of Labor have specific rules about reimbursing individual health insurance premiums.

If you’re not using an IHRA structure, direct stipends may violate the Affordable Care Act’s prohibition on health reimbursement arrangements that don’t comply with IRS rules. This can result in substantial penalties ($100 per employee per day).

An IHRA structure, when properly documented, allows you to legally reimburse individual health insurance premiums while maintaining tax advantages.

Cost Comparison: Real Numbers

Let’s compare costs for a typical small business scenario:

Company: 10 employees, average age 40

Scenario 1: Traditional Group Plan - Annual premium: ~$8,500/employee = $85,000 - Employer pays 80%: $68,000/year ($5,667/month)

Scenario 2: IHRA at $500/month - Annual employer cost: $500 × 12 × 10 = $60,000/year - Individual plans average $600-$800/month (employees cover the difference)

Scenario 3: Stipend at $500/month (non-compliant structure) - Annual employer cost: $60,000/year - However: stipend is taxable income to employees (adds ~$12,000 in imputed income) - Potential compliance penalties: $36,500/year ($100 × 10 employees × 365 days)

Scenario 4: Salary increase of $6,000/year per employee - Annual employer cost: $60,000/year - Employees must use after-tax dollars for health insurance - Less efficient tax treatment

This comparison shows why IHRAs have gained popularity—they offer cost savings while maintaining compliance and tax advantages.

Choosing Your Strategy: Key Questions

Before deciding, ask yourself:

1. What’s our budget? Can we sustain current costs, or do we need to reduce spending?

2. What’s our workforce like? Do our employees value choice and independence, or do they prefer company-provided structure?

3. What’s our retention goal? Are we trying to attract talent, or maintain a stable team?

4. What’s our company culture? Do we emphasize employee autonomy or company paternalism?

5. What geographic market are we in? Individual plan availability and cost vary significantly by region.

6. What’s our compliance appetite? Can we properly maintain an IHRA, or do we need maximum simplicity?

Our Recommendation: The Hybrid Approach

Many of our clients find success with a hybrid strategy:

• Maintain core group coverage for preventive care and catastrophic protection
• Add an IHRA for voluntary coverage expansion or to help employees with non-eligible spouses/dependents
• Communicate the total value clearly so employees understand your full investment

This approach balances cost control with employee satisfaction and compliance certainty.

Next Steps

Evaluating benefit strategies requires understanding your specific circumstances: your employee demographics, financial constraints, market conditions, and culture. There’s no universal “best” answer.

Consider consulting with an independent benefits advisor who can model scenarios for your specific business and help you communicate your chosen strategy effectively to employees.

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Nexus Benefit Solutions is an independent employee benefits advisory firm based in West Michigan. Questions? Reach out at jason@nexusbenefitsolutions.com or call 616-425-9740.