What is a defined contribution in employee health benefits?

The idea behind defined contribution is simple: instead of choosing a health plan for your employees, you give them money to choose their own.

Adam Stevenson

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Adam Stevenson

Jeremy Wolf

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Jeremy Wolf

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"Defined contribution" means providing employees with a benefit of a specific dollar amount. You're probably most familiar with defined contributions in the context of the 401k: your employer provides a fixed amount each month to be contributed to a retirement account.

In terms of employee health benefits, defined contributions can simplify the healthcare expenses of your business significantly. The best part? With options like ICHRA, you can make tax-advantaged contributions.

Traditional Benefits, Schmaditional Benefits

Health benefits have always been a complex topic for startup founders and small business owners. Group health insurance plans can be expensive and come with their own set of challenges:

  • You have to choose a plan that works for everyone, which is hard to do. Different employees have different needs based on a variety of factors (their health situations, family size, age, etc.).

  • You have to deal with the administrative burden of managing the plan. This includes things like enrollment, claims, and compliance. Open enrollment alone is a lot of work!

  • Small group health plans are expensive, and the costs keep going up. This can be a huge burden for small businesses.

Healthcare costs over time are rising quickly

But what if you could just give your employees a set amount of money and let them decide how to spend it on healthcare? That's what defined contributions are all about!

Define "Defined Contribution"

In the simplest terms, a defined contribution is a fixed sum of money that an employer offers to their employees for healthcare costs. It’s like giving your employees a healthcare allowance. They can use this money to purchase individual health insurance policies or pay for other medical expenses. No strings attached. (Almost — more on that below!)

Tax Benefits: Why ICHRA is Your New Best Friend

Defined contributions can be made tax-advantaged through an ICHRA. This essentially means that the money you contribute isn't subject to payroll taxes. Employees also aren't hit with income taxes for the money they spend from the ICHRA, as long as it’s on qualified healthcare expenses. A double win!

Note: Tax rules can be intricate. Always consult a tax advisor to ensure you’re staying within the bounds of the law.

You might be thinking, "This sounds too good to be true; what's the catch?" There are legal constraints to consider. ICHRAs must comply with various federal laws including nondiscrimination requirements. This means you can't favor highly compensated employees over others. Again, always good to have a chat with your legal advisor before diving in.

Setting Up Your ICHRA: Keep Calm and Plan Ahead

  1. Consult a Pro: Before setting up an ICHRA, consult your tax advisor and legal counsel to make sure you're complying with all federal and state laws.

  2. Budgeting: Determine the allowance you can offer. Unlike group plans, this is a fixed cost so you can budget more efficiently.

  3. Employee Input: While optional, it's a good idea to ask your employees what kind of health coverage they’re looking for. Tailor the contribution classes based on this information if you want.

  4. Implementation: Use a reliable third-party administrator to set up and manage the ICHRA. They can help with the nitty-gritty like documenting healthcare expenses and ensuring compliance.

Wrapping Up: Defined Contributions Make Sense

When it comes to health benefits, there’s no one-size-fits-all answer. Defined contributions through an ICHRA offer a viable alternative to traditional group health plans, especially for startups and SMBs. You get tax advantages, your employees get flexibility, and everyone stays on the right side of the law.

Give your employees a defined contribution for healthcare

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Written byAdam StevensonCo-founder

Adam is the co-founder of Thatch. He worked for seven years at Stripe and has six years of experience in healthcare, where he focused on solving the problem of access to great healthcare. He is passionate about living and working in the future.

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