This is a common question that may signal an underlying misconception of the nature of the employee benefit plan under consideration. It makes sense to expand on the distinction between a “health reimbursement arrangement” and a “health reimbursement account” because of the potential to confuse the concepts or the tendency to use the terms interchangeably.
In the past – perhaps ten years ago – it was customary, even among employee benefits professionals, to hear the the terms used interchangeably. More recently employee benefit professionals use only the term “health reimbursement arrangement” and might have considered the term “health reimbursement account” to be just an improper usage or an error. Now the terminology has resurfaced in a new context.
We draw attention to the distinction between the two phrases because of recent surge in popularity of health reimbursement accounts that are part of executive compensation packages not associated in any manner with health reimbursement arrangements.
The former, a Health Reimbursement Arrangement (also known as an HRA) is a tax-qualified employee benefit plan that is not discussed in this Q&A. Please see other pages on this Web site devoted to HRAs. The latter term, a “health reimbursement account” is the subject of the remainder of this Q&A.
A health reimbursement account is a bank account or other accounting entry whose function is to distinguish funds earmarked by an employer for employee health expenses from other general operating expenses of the employer. The separation of funds is an accounting notion only since there is no legal distinction between the health reimbursement account and the employer’s general operating funds.
Funds placed into a health reimbursement account are not tax deductible and are treated in the same manner as funds in any other regular employer-owned account. The funds are subject to attachment by general business creditors
, the same as any other general business funds. Interest, if any, is taxable to the employer. If the funds are paid to employees then this amount is taxable compensation (just like wages) unless a specific tax law (like IRC code section 105 or 125) allows them to be paid to employees tax-free. In other words, a health reimbursement account has no tax status or effect.
An employer may wish to eventually use the funds in the health reimbursement account to pay for employee health expenses in a manner that would make the expenses deductible to the business and tax-free to the employee. Any of the qualified health plans discussed elsewhere in this Web page can be used, including the HRA that was mentioned earlier in this article.
In some other cases employers use health reimbursement accounts to fund executive health benefits that are not tax-qualified benefits under any available option. The funds may be earmarked for owners, highly compensated employees or key employees whose health benefits are subject to additional tax restrictions. In this sense, the health reimbursement account serves the same purpose and function as funding a deferred compensation account for executive employees. In these cases it may be appropriate to refer to the health reimbursement account as a non-qualified account, indicating their lack of tax advantages.
Additionally, some employers ask whether it is possible to establish a health reimbursement account for each employee. This is possible and is becoming increasingly popular; but again this serves no legal purpose or function other than to earmark a specific sum of the employer’s funds that are intended for a specific employee’s future health expenses.
Finally, please be aware that “health reimbursement arrangement” is a term recognized in official tax publications and laws and therefore has a specific legal definition. In contrast, the term “health reimbursement account” is not a legally recognized term so some people may choose to take liberties in the usage of the phrase and define it as they wish. Our interpretation, we believe, represents the consensus of the employee benefit profession. Yet we are aware that some benefits salespeople deliberately interchange the use of these two terms to facilitate sales-related discussions. (It makes sense to have two phrases describe what you are selling rather than take the time that to say that you can not sell one of the two and then describe the difference).
Other resources:
article: “How to establish separate employee bank accounts in a small business HRA plan”