For decades, the only realistic way an employer could offer pre-tax health benefits was to sponsor a group health plan. That changed in 2020 when federal regulation introduced the Individual Coverage Health Reimbursement Arrangement (ICHRA), a structure that lets employers fund employees’ individual market coverage with pre-tax dollars instead of running a group plan.
The ICHRA has quietly become one of the most flexible benefits tools in the small-employer toolkit. For the right business, it delivers tax-advantaged employee health benefits, predictable employer cost, and a level of flexibility that traditional group plans can’t match. Here’s what ICHRAs are, how they work, and when they make sense.
What is an ICHRA?
An ICHRA — Individual Coverage Health Reimbursement Arrangement — is an IRS-approved structure that lets an employer:
- Set a defined monthly allowance (or annual amount) per employee
- Have the employee use that allowance to buy individual market health insurance and pay other qualified medical expenses
- Reimburse the employee tax-free for those expenses, up to the allowance amount
The employer’s contribution is excluded from the employee’s gross income and isn’t subject to FICA/Medicare tax, the same favorable tax treatment as employer-paid group plan premiums.1
The structure was created by federal regulation issued by the IRS, DOL, and HHS in June 2019, with the rules taking effect for plan years starting on or after January 1, 2020.
How an ICHRA works
The mechanics, end to end:
Step 1: Employer designs the ICHRA
The employer (with a benefits advisor or ICHRA admin vendor) defines:
- Allowance amounts: how much per employee per month
- Employee classes: whether different classes get different amounts
- Eligible expenses: individual market premiums and other qualified medical expenses under IRC §213(d)
- Plan year: usually aligned with the calendar year
- Rollover rules: whether unused balances roll over (employer’s choice)
The plan must be documented in a written plan document that meets IRS and DOL requirements.
Step 2: Employee enrolls in qualifying coverage
Employees use the ICHRA allowance to enroll in individual market health insurance. This can be:
- A plan from the federal or state ACA marketplace
- A plan purchased directly from a carrier
- Medicare (in some specific cases)
The plan must be ACA-qualifying coverage. Short-term limited-duration plans, association plans, and faith-based health-sharing ministries do NOT qualify.
Step 3: Reimbursement flow
Each month (or per pay period, depending on plan design):
- Employee pays their individual market premium and any other qualified expenses
- Employee submits documentation to the ICHRA administrator (or uses a debit card / instant reimbursement system depending on the admin platform)
- Administrator verifies eligibility and reimburses tax-free up to the available allowance
If the employee’s qualifying expenses are less than the allowance, the unused portion remains in the ICHRA (and rolls over or is forfeited per the plan design). If expenses exceed the allowance, the employee covers the difference out of pocket.
Employee classes: the key flexibility lever
One of the most powerful features of an ICHRA is the ability to define employee classes and offer different allowance amounts to different classes. The IRS allows classes based on:
- Full-time vs. part-time
- Salaried vs. hourly
- Geographic rating area (by where the employee lives)
- Seasonal employment
- Employees with same-as-class waiting periods
- Employees in collective bargaining
- Foreign vs. domestic
- Combinations of the above (e.g., full-time salaried in California)
The employer must offer the same terms to everyone within a defined class; they can’t pick and choose individuals. Class-based design lets an employer differentiate generously without violating nondiscrimination rules.
For example: an employer might offer:
- Full-time employees: a meaningful monthly allowance to support family-affordable individual coverage
- Part-time employees: a lower monthly allowance suitable for self-only coverage
Both classes get equal-within-class treatment; the employer’s total commitment is predictable.
Tax treatment
Properly structured ICHRA reimbursements are:1
- Excluded from employee gross income (federal and most state income tax)
- Not subject to FICA, FUTA, or Medicare on either the employer or employee side
- Deductible to the employer as a business expense
An employer dollar of ICHRA contribution is more tax-efficient than an equivalent dollar of salary by the FICA/Medicare savings (7.65% on each side) plus the income-tax savings to the employee.
ICHRA vs. group plan: side by side
| Factor | Group Health Plan | ICHRA |
|---|---|---|
| Carrier selection | Employer chooses one (or a few) carriers | Employee chooses any qualifying individual plan |
| Network | Plan-defined, typically regional | Plan-defined, varies by employee’s chosen carrier |
| Employer cost predictability | Subject to renewal increases | Defined allowance — predictable |
| Group underwriting | Yes (claims experience affects renewal) | No (individual market rating per employee) |
| Multi-state coverage | Often weak with regional carriers | Strong — each employee picks their state’s market |
| Minimum participation | Usually required (carrier-defined threshold) | None |
| Minimum group size | Usually 2+ for small group | None (one-person ICHRAs are valid) |
| Plan administration | Carrier handles | Employer + ICHRA admin handle |
| Employee experience | Uniform for all enrollees | Differentiated by employee choice |
ICHRAs trade some uniformity and simplicity for flexibility, predictability, and broader coverage for distributed workforces.
When an ICHRA makes sense
ICHRAs work best for:
Very small employers (under 10 employees). Group plan economics are expensive per head at this size. ICHRAs scale linearly with the number of employees, with no minimum participation worries.
Distributed workforces. Employees in multiple states are hard to serve with a regional group plan. With an ICHRA, each employee buys coverage in their own state’s market.
Employers with diverse employee needs. Different family stages, different geographic preferences, different age profiles. ICHRA classes let the employer differentiate appropriately.
Employers wanting cost predictability. The defined monthly allowance is the employer’s commitment. There’s no “renewal increase” risk, only the employer’s own decision to adjust the allowance.
Employers replacing an underperforming group plan. Many employers tired of double-digit renewal increases find ICHRA economics more sustainable.
Recruiting in markets where employees value flexibility. Tech, professional services, and creative industries value the ability to choose their own coverage.
When an ICHRA doesn’t make sense
Highly homogenous workforces concentrated in one geography where a group plan offers competitive economics and uniform experience.
Large employers (200+) with strong group plan negotiating leverage. Group plan scale economics win.
Employers whose employees mostly qualify for ACA premium tax credits without ICHRA — the math gets nuanced, since ICHRA participation removes tax credit eligibility for that coverage.
Workforces with strong attachment to specific group plan benefits the ICHRA can’t replicate (specific networks, specific carrier relationships).
ICHRA Pros and Cons walks through this trade-off in more depth.
ICHRA vs. QSEHRA
ICHRA isn’t the only HRA option for small employers. The QSEHRA (Qualified Small Employer HRA) is an older, simpler variant with annual contribution limits set by the IRS and a more constrained structure. The choice between them depends on:
- Group size (QSEHRA is for under-50 employers; ICHRA has no size cap)
- Desired contribution level (ICHRA can exceed QSEHRA’s IRS-set limits)
- Whether you want to differentiate by employee class (ICHRA supports it; QSEHRA generally doesn’t)
- Whether the employer also offers a group plan (ICHRA can coexist for different classes; QSEHRA cannot)
ICHRA vs QSEHRA walks through the side-by-side comparison.
The ACA tax credit interaction
The ICHRA’s interaction with ACA premium tax credits is the trickiest part of the design.
If an employee accepts ICHRA coverage, they cannot also receive ACA premium tax credits for that individual market plan. If the ICHRA is “affordable” under IRS rules, the employee’s only path to coverage through this employer is the ICHRA.
If the ICHRA is “unaffordable” (the employee’s required share of self-only coverage exceeds an IRS-defined affordability threshold), the employee can opt out and instead receive ACA tax credits on their own individual coverage.
For most employees, the math favors the ICHRA over tax credits because:
- ICHRA dollars are pre-tax to both employer and employee (FICA/Medicare savings)
- Tax credits are sliding-scale by income; many employees in the small-employer market would only qualify for partial credits
- ICHRA gives a guaranteed defined contribution; tax credits depend on income and family size
But the math doesn’t always work this way. For lower-income employees in expensive insurance markets, the tax credit path may be more economical. A benefits advisor familiar with the rules should model specific employee scenarios when designing an ICHRA.
The ICHRA isn’t replacing the group plan everywhere — but it’s becoming a real alternative for businesses where the group plan never quite fit. Distributed workforces, very small employers, and businesses with diverse employee situations are finding the ICHRA structurally cleaner than the traditional model.
Implementation
To set up an ICHRA, an employer:
- Hires a benefits advisor or ICHRA admin vendor experienced with the structure
- Defines plan parameters (classes, allowance amounts, eligible expenses, plan year)
- Adopts a written plan document meeting IRS and DOL requirements
- Enrolls a third-party administrator to handle reimbursements and substantiation
- Communicates the offering to employees with adequate education on selecting individual coverage
- Aligns with ACA reporting requirements (Form 1095-B or 1095-C as applicable)
The complexity is real but well-understood. Vendors like Take Command, Gusto, ADP, and others all offer ICHRA admin platforms that handle most of the operational lift.
Where this leaves you
An ICHRA (Individual Coverage Health Reimbursement Arrangement) is one of the most significant additions to the small-employer benefits toolkit in years. For employers whose group plan fits awkwardly (too expensive at small scale, too rigid for a distributed team, too uniform for diverse employee needs), the ICHRA offers a flexible alternative with strong tax advantages and predictable employer cost.
It’s not the right answer for every employer. But it’s the right answer often enough now that no business should choose a group plan without at least running the ICHRA comparison alongside it.
Want help modeling whether an ICHRA fits your business? We can compare ICHRA economics against your current or proposed group plan, walk through employee class design, and identify whether the structure delivers a better outcome for your specific workforce. Talk to us.
Footnotes
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IRS, Health Reimbursement Arrangements (HRAs) and Other Account-Based Group Health Plans — final regulations issued June 2019 by the IRS, DOL, and HHS that authorized ICHRAs. See also IRS Publication 969 and HRA guidance for ongoing administrative rules and tax treatment. ↩ ↩2