How do the ICHRA and Section 125 cafeteria plan work together?

The Individual Coverage Health Reimbursement Arrangement (ICHRA) is the newest and most customizable HRA model available. It lets employers forego one-size-fits-all traditional group health plans in favor of reimbursing employees for the health insurance they choose. Employers can enhance tax-saving benefits by pairing the ICHRA and Section 125 cafeteria plan.

How tax-saving benefits work: HRA vs. Section 125

HRA tax savings

HRAs reimburse employees for eligible medical expenses with dollars that are tax-free to the employee and a normal business tax deduction for the employer. It’s a great way to put money for health coverage directly in the hands of the employee.

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Section 125 tax savings

Section 125 plans use pre-tax salary deductions to pay eligible medical expenses. A basic Section 125 premium-only plan (POP) covers premiums for medical insurance and supplemental coverage while the Section 125 cafeteria plan expands tax-savings to Health Flexible Spending Arrangements (FSA) and Health Savings Accounts (HSA).

Every dollar that passes through a Section 125 plan via salary deductions brings tax savings to both the employee and the employer. The employee saves up to 40%¹ from FICA and income taxes (federal and most state taxes) while to employer saves up to 10% in matching FICA tax, FUTA, and in some cases state unemployment and/or worker compensation tax.

That means every $1,000 in a Section 125 plan can save an employee up to $400 and the employer $100 in taxes. This can add up quickly when employees make balance-of-premiums payments as well as FSA and HSA contributions for additional pre-tax funds to cover medical expenses.

Balance of individual coverage premium payments

The first way an employer might use an ICHRA and Section 125 plan to increase tax savings is to allow employees to pay the balance of individual coverage health insurance premiums through the Section 125 POP.

Here’s how it works: Let’s say an employer provides $600 per month for individual coverage premiums in an ICHRA. An employee may have a monthly health insurance premium of $1,000 for a family of four. The employer allows the employee to set up a monthly $400 balance-of-premium payment to the insurance provider.

Other premium payments

Under the Section 125 POP, an employer can offer supplemental benefits, such as group term life insurance, that will be paid with pre-tax salary deductions.

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Health FSA contributions

An employer can up their tax-saving benefits game by combining an ICHRA and Section 125 cafeteria plan to offer a Health FSA for employee contributions in a Section 125 cafeteria plan. An employee can set aside up to $2,700² pre-tax per plan year for non-premium medical expenses, including deductibles, co-pays, co-insurance, prescription, dental and vision. Many non-prescription medical items are also eligible for coverage through a Health FSA.

With an employer-sponsored Health FSA, the sponsor determines whether it is a general FSA or a limited-purpose design as well as how much employees may contribute (up to the annual limits) and if there is a grace period or partial rollover ($500 maximum) for unused funds at the end of a plan year.

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HSA contributions

Employees with a qualifying high-deductible health plan (HDHP)³ can deposit up to $7,100³ into a new or existing HSA when the employer provides this option in a combination ICHRA and Section 125 plan. For these employees, the ICHRA terms must state that either the ICHRA reimburses premiums only or premiums plus only post-deductible⁴ medical expenses.

A Health FSA for employees with an ICHRA and HSA must be a limited design that pays only dental and vision expenses.

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