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Life Health > Health Insurance

Dodging Steep Penalties in Retiree-Only HRA Design

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While the Affordable Care Act (ACA) market reform provisions have undoubtedly limited the usefulness of health reimbursement arrangements (HRAs), when it comes to pre-Medicare age retirees, these vehicles may still prove to be an important tool for employers.

HRAs were once a popular vehicle that employers funded to assist employees with the cost of health insurance coverage without actually providing such coverage through their own plans—a strategy that can now generate steep penalties. Despite this, an exception allows employers to continue to provide assistance through HRAs to retired employees (who may be eligible for premium assistance tax credits) while reducing the employer’s exposure to the Cadillac tax—if the proper steps are taken to ensure that the HRA qualifies as a retiree-only HRA.

The Danger With HRAs

The Treasury Department has issued guidance prohibiting the use of most HRAs that are not “integrated” with other group health coverage provided by the employer (or a spouse’s employer) because HRAs are treated as group health plans that violate the ACA prohibition on annual benefit limits.  As a result, employers that offer a stand-alone HRA would become subject to a $100 per day, per employee penalty, up to a cap of $36,500 per year, beginning July 1, 2015—which has caused many employers to discontinue HRA programs.

However, HRAs that are offered to fewer than two participants who were current active employees on the first day of the plan year (this includes retirees) are exempt from the market reform provisions.

Designing a Retiree-Only HRA

The exception that allows employers to offer non-integrated HRAs to retirees can allow employers to continue providing premium assistance through tax-preferred HRAs without penalty as long as the HRA is designed as a retiree-only HRA (or covers only a single individual). These retirees can use their HRA funds to purchase individual health insurance through the health insurance exchanges (retirees are generally eligible to purchase health coverage through the exchanges as long as they are not yet eligible for Medicare coverage).

While definitive guidance as to what constitutes a retiree-only HRA has not been released, it is clear that the plan cannot cover active employees—including previously retired employees who have returned to work. It is, therefore, important for employers designing retiree-only HRAs to take steps to ensure that they are operated separately from any other group health coverage that is provided.

This means that plans for retiree-only and active employees should maintain separate plan documents and summary plan description (SPD) materials, and that all administrative functions should be performed separately for each. Further, each type of plan should have a separate Form 5500 filing.  Any funding or contracts with respect to the retiree-only HRA should also be kept separate from those that are used in connection with coverage for active employees.

Cadillac Tax Impact

Beginning in 2018, employers can become subject to a 40% excise tax if the cost of employer-sponsored health coverage exceeds certain threshold levels. The 40% tax is imposed on the cost of coverage that exceeds the annual limits. 

While definitive guidance on the application of the tax has not been released, the IRS has indicated that HRAs will count in determining whether the thresholds will be crossed. The “cost” of an HRA could be determined by using one of three methods (or a combination of the three):

(1) the amounts made newly available to a participant each year

(2) the claims and administrative expenses attributable to the HRA for the period or

(3) the actuarial basis method.

However, use of an HRA allows the employer to fund the HRAs with an annual amount that does not cross the Cadillac tax threshold—meaning that the vehicle can be used to shield the employer from Cadillac tax applicability, assuming the employer has the choice of using option (1), above, to value the HRA.


Definitive regulatory guidance on designing and using a retiree-only HRA is lacking, though several courts have recently blessed the retiree-only HRA—so employers who choose to proceed with this potentially valuable strategy should be advised to pay close attention to future guidance as it is released.

Originally published on Tax Facts Onlinethe premier resource providing practical, actionable and affordable coverage of the taxation of insurance, employee benefits, small business and individuals.    

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