Health Reimbursement Arrangements (HRAs) have become increasingly popular tools for small business owners seeking flexible, cost-effective healthcare solutions. Yet many advisors still struggle to explain HRA mechanics clearly to clients or understand when to recommend them over competing strategies.

This guide covers what you need to know to confidently position HRAs across different client segments and help business owners make informed decisions.

What Is an HRA?

An HRA is an employer-funded, account-based health benefit that reimburses employees for qualified medical expenses and, in most cases, individual health insurance premiums. Unlike traditional group health plans, the employer doesn’t actually provide or arrange the insurance—employees purchase their own coverage, and the HRA reimburses them tax-free.

The IRS governs HRAs under Internal Revenue Code Section 105. The arrangement must be written, funded solely by the employer (employees cannot contribute), and administered fairly across eligible employees.

Key Characteristics

Employer-funded only: Employers deposit funds into the HRA. Employees never contribute directly, though premium contributions may be reduced through payroll deductions.

Tax-free reimbursements: Employees receive reimbursements for qualified medical expenses without federal income tax, payroll tax, or self-employment tax consequences.

Forfeiture rules: Unused funds at year-end don’t carry over to the next year under traditional HRA design (though carryover is permitted in specific HRA types).

Employer control: The employer defines eligible expenses, reimbursement rates, and employee eligibility.

HRA Types and Modern Variations

The HRA landscape has evolved considerably. Understanding the different types helps you match solutions to client needs.

Traditional HRA (Integrated HRA)

The classic model: employers offer group health insurance and an HRA to cover out-of-pocket costs, deductibles, and copays. This arrangement reduces employee cost-sharing and encourages preventive care utilization.

Best for: Mid-size employers (50+ employees) with existing group plans seeking to enhance benefits and reduce turnover.

Individual Coverage HRA (ICHRA)

Introduced in 2020, the ICHRA represents a paradigm shift. Employers provide a defined contribution amount that employees use to purchase individual health insurance on the ACA marketplace—or from off-marketplace sources—and the HRA reimburses premiums and out-of-pocket costs.

No group plan is required.

Best for: Small businesses (under 50 employees), startups, and employers wanting maximum flexibility and employee choice.

Qualified Small Employer HRA (QSEHRA)

Available to employers with fewer than 50 employees, the QSEHRA operates similarly to the ICHRA but with stricter contribution limits and coverage requirements.

Best for: Very small employers (under 50 FTEs) seeking a simple, compliant approach to supporting employee health insurance purchases.

Tax Advantages: Why HRAs Matter

The tax efficiency of HRAs is their primary selling point—for employers and employees.

Employer Tax Benefits

Deductible contributions: Employer HRA funding is a fully deductible business expense, reducing taxable income dollar-for-dollar.

No payroll taxes on reimbursements: Unlike wages, HRA reimbursements for qualified medical expenses avoid FICA (Social Security and Medicare) taxes. For employers, this means savings on the employer portion of payroll taxes—typically 7.65%.

Example: A business with 10 employees funding a $150/month ICHRA saves approximately $1,140 annually in employer payroll taxes alone, beyond the income tax deduction.

Predictable costs: HRAs operate on a defined-contribution model. Employers know exactly what they’ll spend each month, making budgeting straightforward.

Employee Tax Benefits

Tax-free reimbursements: Employees receive reimbursements without federal income tax withholding, making their actual take-home stronger.

No self-employment tax: Self-employed individuals and S-corp owners avoid self-employment taxes on reimbursed amounts.

ACA subsidy preservation: Under ICHRA and QSEHRA rules, employees can access ACA marketplace subsidies based on their household income, not employer-provided benefits. This is a game-changer for lower-income employees and part-time workers.

Example: An employee earning $35,000 annually purchasing a $300/month marketplace plan might qualify for a $250 subsidy. The employer reimburses the remaining $50, and the employee’s true cost is minimal—far better than a traditional group plan with high employee contributions.

HRA vs. Competing Strategies

Understanding how HRAs compare to alternatives helps you guide clients to the right solution.

HRA vs. HSA

HSA (Health Savings Account): Triple-tax-advantaged accounts tied to high-deductible health plans. Individuals contribute (and get a deduction), funds roll over indefinitely, and withdrawals for qualified medical expenses are tax-free.

HRA: Employer-funded, reimbursements are tax-free, but unused balances may not carry over in traditional designs.

When to recommend HSA: Employees want to build long-term health savings; younger, healthier workforces; employees with low expected medical expenses.

When to recommend HRA: Employers want simplicity; cost-sharing support is the goal; employees need flexibility in insurance choices (particularly ICHRA).

Note: HRAs and HSAs can coexist, though careful coordination is necessary to avoid violating ACA preventive care rules.

HRA vs. Group Health Plan

Group plan: Employer arranges and partially funds comprehensive coverage.

HRA: Employer funds reimbursements; employees purchase individual or off-marketplace coverage.

Group plan advantages: Negotiated rates, employer control over plan design, simplified compliance, appeal to employees seeking comprehensive benefits.

HRA advantages: Lower employer costs in many cases, maximum employee choice, reduced administrative complexity, better ACA subsidy outcomes for lower-wage employees.

Compliance Essentials

HRA compliance isn’t optional—it’s foundational to the strategy’s viability.

Documentation Requirements

Written plan document: Every HRA must have a written plan describing eligibility, contribution amounts, covered expenses, and claims procedures. The IRS doesn’t require a specific form, but the document must be clear and comprehensive.

Notice requirements: Employers must provide employees with plan information, including summary of benefits and coverage (SBC) documentation where applicable.

Recordkeeping: Maintain detailed records of contributions, reimbursements, and eligible expense substantiation for at least three years.

Common Compliance Pitfalls

Treating HRA funds as wages: Reimbursements must be for qualified medical expenses—not general salary supplements.

Discriminatory plan design: HRAs cannot reimburse expenses for highly compensated employees differently than rank-and-file employees.

Failure to comply with ICHRA rules: If offering an ICHRA, ensure you’re not requiring employees to waive ACA protections (such as preventive care coverage).

Inadequate substantiation: Require employees to document reimbursement requests with receipts and EOBs.

Positioning HRAs to Different Client Segments

Startups and Micro-Businesses (1-10 Employees)

Challenge: Limited budget; need to attract talent despite size.

HRA solution: ICHRA offers flexibility without group plan infrastructure. Contributes $150-$200/month per employee—far less than group plan premiums—and employees access marketplace subsidies.

Advisor angle: “You fund reimbursements; employees manage their own coverage. Simple, predictable costs, and your team gets subsidized marketplace plans.”

Small Businesses (11-50 Employees)

Challenge: Group plans become expensive; turnover is costly.

HRA solution: QSEHRA or ICHRA. Consider pairing with voluntary benefits for supplemental coverage.

Advisor angle: “Define your contribution. Employees choose their plan. You control costs while offering meaningful health support.”

Mid-Size Businesses (50+ Employees)

Challenge: Group plan costs rising; employee satisfaction declining.

HRA solution: Integrated HRA paired with group coverage. Reimburse deductibles, copays, and out-of-pocket costs.

Advisor angle: “Enhance your existing plan affordability and employee satisfaction without increasing the group rate. Focus HRA dollars on high-deductible support.”

Implementation Best Practices

Educate early: HRAs are unfamiliar to many employees. Invest in clear communication about how the plan works and why it’s beneficial.

Choose the right vendor: Work with a third-party administrator (TPA) experienced in HRA administration. They handle compliance, reimbursement processing, and record maintenance.

Coordinate benefits: If employees have HSAs, coordinate with your HRA to ensure compliance. If offering voluntary benefits, clarify which expenses the HRA covers.

Review annually: Assess contribution amounts, eligible employee populations, and expense patterns. Adjust as needed.

Conclusion

HRAs represent a legitimate, tax-efficient alternative to traditional group health benefits—particularly for small employers and those seeking flexibility. By understanding HRA mechanics, tax advantages, compliance requirements, and positioning strategies, you can confidently guide clients toward the solution that best fits their workforce, budget, and objectives.

The key is matching the right HRA type to the right client segment and maintaining clear communication throughout implementation and administration.

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.

HRA Fundamentals: What Advisors Need to Know