What Is an HRA? Types, Rules, and Employer Setup
An HRA is an employer-funded arrangement that reimburses employees tax-free for medical costs. The five types, which you can legally offer, and the setup.
The first time somebody explained an HRA to me, they described it as an account. Usually it is a promise to reimburse instead: nothing is deposited, no balance exists anywhere, and if nobody claims all year, you spend nothing. That distinction is the first of three things to get straight before you offer an HRA, and it explains almost every rule that follows.
The second is that you do not get a free choice of HRA. Two facts about your business decide which ones are open to you, and most of the published comparisons skip straight past that to a feature table you cannot act on.
The third is the expensive one. There is a version of this that looks obvious, costs nothing to set up, and carries an excise tax of $100 per day per employee. Small businesses walk into it every year because it is exactly what a reasonable person would do.
I build the people and records tooling for businesses without an HR department at FirstHR. This is general information, not legal or tax advice, and the plan document always wins over any summary.
What an HRA Actually Is
A health reimbursement arrangement (HRA) is an employer-funded benefit that reimburses employees, tax-free, for qualifying medical expenses. The employer sets the amount, the employer funds it, and nothing is paid until an employee submits a substantiated claim, meaning one backed by proof of the expense. The reimbursement is excluded from the employee's income and deductible to the business.
Three properties follow from that definition, and they are the ones that surprise employers coming from a flexible spending account (FSA).
Only the employer funds it. There is no salary reduction, no election, and no employee contribution of any kind. That makes an HRA a cost line rather than a payroll mechanic, and it also means it cannot be run through a cafeteria plan the way a spending account is.
It is usually notional rather than funded, meaning you promise to reimburse up to a ceiling instead of setting money aside. If nobody claims, you pay nothing, which is why generous-looking allowances frequently cost far less than the headline figure multiplied by headcount.
And every type except the QSEHRA is a group health plan, legally speaking, with the obligations that come with one (26 U.S.C. 9831(d)(1)). That is the part small employers underestimate, because the arrangement itself feels informal and the compliance around it is not.
The Five Types
Five arrangements are in common use: the integrated HRA, the excepted benefit HRA, the QSEHRA, the individual coverage HRA (ICHRA), and the retiree HRA. They differ on two axes that matter more than the rest: whether you must also sponsor a group health plan, and whether the arrangement may reimburse insurance premiums.
| Type | Requires a group plan? | Reimburses premiums? | Dollar cap |
|---|---|---|---|
| Integrated HRA | Yes, and the employee must be in group coverage, though it can be a spouse’s plan | Not individual policies; mainly out-of-pocket costs | None set federally |
| Excepted benefit HRA | Yes, but the employee need not enroll | Limited, mainly excepted coverage such as dental and vision | $2,250 newly available for plan years beginning in 2027 |
| QSEHRA | No, and you must not offer one | Yes, individual market premiums and medical costs | $6,450 self-only and $13,100 family for 2026 |
| ICHRA | No, not to the employees you cover with it | Yes, individual market and Medicare premiums | None set federally |
| Retiree HRA | No | Yes, including Medicare premiums | None set federally |
The integrated HRA is the oldest design and the one most people picture. You keep your group plan, and the arrangement absorbs some of the deductible and out-of-pocket exposure your employees would otherwise face. It only covers people enrolled in group coverage, which is both its point and its limitation. Coverage through a spouse's plan counts too (29 CFR 2590.715-2711(d)(2)).
The excepted benefit HRA is the least known and the most useful for its size. It is capped, it sits alongside a group plan, and crucially an employee may use it even if they decline your medical coverage, which makes it a genuine option for the person on a spouse's plan who currently gets nothing from you.
QSEHRA and ICHRA are the two that replace a group plan rather than supplement one, and they are the ones most small businesses are actually choosing between.
Federal marketplace materials now call the ICHRA a CHOICE Arrangement (HealthCare.gov). The federal regulation that sets its rules, 26 CFR 54.9802-4, still calls it an individual coverage HRA, so you will see both names for the same arrangement.
Which One You Are Allowed to Offer
You do not choose freely among the five. Two facts about your business close most of the doors before preference enters into it: whether you sponsor a group health plan, and how many full-time equivalents you employ.
The 50 full-time equivalent line is the one to establish first if you are anywhere near it, because it is also the threshold for the employer mandate and it is calculated in a specific way rather than by counting heads. Part-time hours aggregate into equivalents, which regularly puts businesses over a line they assumed they were under.
The other thing worth settling early is that offering a group plan and offering an ICHRA to the same employees is not permitted (26 CFR 54.9802-4). You may split by legitimate employee classes, such as full-time versus part-time, or by geography, but you cannot hand the same person both and let them choose. That constraint kills a design a lot of employers think they want.
The Version That Costs $36,500 Per Employee
Here is the arrangement almost every small business owner independently invents: an employee buys their own policy, you reimburse them for it or pay the insurer directly, and you treat it as a health benefit rather than as wages. It carries the largest penalty in this entire subject.
That is an employer payment plan. The IRS treats it as a group health plan, and it fails the Affordable Care Act's federal market reform requirements because it imposes an annual dollar limit on essential health benefits. The excise tax under Section 4980D runs at $100 per day per affected employee, which reaches $36,500 per employee per year (Internal Revenue Service).
Two legitimate exits exist. The first is to route the reimbursement through a QSEHRA or an ICHRA, which is the whole reason those arrangements were created, and which converts the same dollars into a compliant tax-free benefit.
The second exit is to pay the money as ordinary taxable wages with no conditions attached. That is permitted because unconditional compensation is not a health plan, though both sides lose the tax advantage and the employer owes payroll tax on top.
What you cannot do is the middle position: paying the money but requiring proof of an insurance purchase. Conditioning payment on coverage is exactly what turns compensation into a health plan, and it is the detail that catches employers who thought they had structured around the problem.
Contribution Limits
Two of the five types are capped and three are not. For 2026 the QSEHRA maximum is $6,450 for self-only coverage and $13,100 for family coverage, per Revenue Procedure 2025-32. The excepted benefit HRA is capped at $2,250 newly made available for plan years beginning in 2027, per Revenue Procedure 2026-24. Integrated HRAs, ICHRAs, and retiree HRAs carry no federal dollar limit.
| Type | Current federal limit | Who sets the real number |
|---|---|---|
| QSEHRA | $6,450 self-only, $13,100 family for 2026 | You, up to the cap. Amounts may vary by age and family size but not much else |
| Excepted benefit HRA | $2,250 newly made available for plan years beginning in 2027 | You, up to the cap. Unused amounts may carry over above the cap |
| ICHRA | No federal cap | You, subject to affordability testing if you are a large employer |
| Integrated HRA | No federal cap | You, constrained by the group plan it sits on top of |
| Retiree HRA | No federal cap | You, with far fewer constraints than any active-employee version |
The absence of a cap is less liberating than it sounds. An uncapped arrangement means you set the number with no guardrail, and the number you set becomes an ongoing commitment employees budget their household around. In practice the constraint is your budget and the local cost of individual coverage, and it is worth sizing against what you already spend on benefits per employee before announcing anything.
The capped figures are indexed for inflation and updated by revenue procedure, which means an allowance expressed as a percentage of the cap needs rechecking annually, while a flat dollar amount stays put. The flat amount has a different weakness: its real value erodes quietly against premium inflation unless somebody revisits it.
What an HRA Can Reimburse
An HRA can reimburse qualifying medical care expenses as the tax code defines them, which covers diagnosis, cure, mitigation, treatment, or prevention of disease. That is the same universe that governs most tax-advantaged health accounts. Where the types differ is on premiums.
| Expense | Integrated HRA | QSEHRA and ICHRA | Excepted benefit HRA |
|---|---|---|---|
| Deductibles, copays, coinsurance | Yes, the core purpose | Yes | Yes |
| Prescription costs | Yes | Yes | Yes |
| Dental and vision | Depends on plan design | Yes | Yes, a primary use |
| Individual market premiums | No | Yes, the defining feature | No |
| Medicare premiums | Generally no | Yes for an ICHRA and a QSEHRA | No |
| Continuation coverage premiums | Generally no | A QSEHRA yes, an ICHRA no | Yes |
| Over-the-counter items | Depends on plan design | Depends on plan design | Depends on plan design |
The continuation coverage row deserves a note. An individual coverage HRA is integrated with individual health insurance coverage or Medicare rather than with a group plan (Internal Revenue Service), and it must require the participant and any covered dependents to be enrolled in that coverage for every month it reimburses them (26 CFR 54.9802-4(c)(1)).
Continuation coverage from a former employer is neither of those things, so an ICHRA cannot reimburse the premium. A QSEHRA sets a lower bar: it asks only that the employee carry minimum essential coverage, and continuation coverage counts as minimum essential coverage.
The employer can narrow this list but not widen it. A plan document may cover the full qualifying universe or restrict reimbursement to a specific category, and restricting it is sometimes the point: a limited purpose design covering only dental and vision is what preserves health savings account eligibility for employees on a high deductible plan.
Substantiation is the operational reality behind all of it. Every reimbursement needs proof that the expense was incurred and qualifies, and paying without that proof converts a tax-free reimbursement into taxable wages. This is the workload that makes people hire an administrator, and it is the failure mode that turns a well-meaning informal arrangement into a payroll correction.
HRA Reimbursement Rules That Decide Whether a Claim Gets Paid
Whether the expense qualifies is only half the question. Four timing and ordering rules in IRS Notice 2002-45 decide whether a substantiated, otherwise perfectly good claim can actually be paid, and each of them has caught an employer running the arrangement on instinct.
| Rule | What it means when a claim lands on your desk |
|---|---|
| The expense must be incurred after the arrangement exists | An HRA cannot reimburse anything incurred before the plan came into existence, or before that particular employee first enrolled in it. Backdating a first-year arrangement to catch January expenses does not work. |
| Coverage is tested on the date of the expense | A claim from an earlier coverage period can be paid in a later one, but only if the person was actually covered by the arrangement on the day the expense was incurred. |
| The full annual amount need not be available on day one | Unlike a health flexible spending account, an HRA may make the allowance available monthly rather than all at once. Under that design, a mid-year leaver has only ever had access to what accrued. |
| The HRA is exhausted before a health FSA | Where both cover the same expense, the HRA pays first unless the HRA plan document reverses the order, and that reversal has to be written before the FSA plan year begins. Nobody gets the same expense paid twice. |
One more rule, about cash, has the widest blast radius of all. If any person can take cash or some other benefit from the arrangement instead of a medical reimbursement, every distribution to every participant that year becomes taxable, including the legitimate medical ones.
The cash rule is why an unused balance can never be paid out at departure, and why a retirement bonus sized to somebody's remaining allowance contaminates the whole plan.
What a Limited Purpose HRA Is
A limited purpose HRA is not a sixth type. It is one of the five types, narrowed by its plan document to dental care, vision care, and preventive care only. The narrowing exists for a single reason: to leave health savings account eligibility intact for employees on a high deductible plan.
Revenue Ruling 2004-45 is where that comes from. An arrangement paying only vision, dental, and preventive care may reimburse those costs whether or not the deductible has been met, and the employee covered by it stays eligible to contribute to a health savings account (HSA).
The post-deductible design reaches the same result by a different route, and one plan document can carry both. A post-deductible arrangement pays nothing until the employee has met the minimum annual deductible that a high deductible plan must have, and an expense incurred before that point cannot be reimbursed afterwards, even once the deductible is met.
Do not confuse either design with the excepted benefit HRA, which is a distinct arrangement with its own dollar cap and its own condition about offering a group plan. A limited purpose restriction, by contrast, is something you write into the plan document of whichever arrangement you already run.
Rollover, and What Happens to Money Nobody Claims
Rollover in an HRA is the employer's decision, and that is a genuine advantage over a flexible spending account, where the rules are fixed and the carryover is capped by the IRS. Your plan document can allow a full carryover, a partial one, or none at all.
A QSEHRA puts a ceiling on that choice. It may carry unused amounts forward, but the carryover plus the new year's allowance can never exceed that year's statutory limit (IRS Notice 2017-67).
Because the arrangement is usually notional rather than funded, a generous rollover is cheaper than it looks. With nothing set aside, carrying an unused allowance forward costs nothing unless and until somebody actually claims against it. The real exposure is the tail: a long-tenured employee accumulating several years of unused allowance and then having an expensive year.
When someone leaves, the unused amount stays with you. There is no payout, no vesting, and nothing to transfer, because the employee never owned it. Some plans allow a departing employee a defined window to submit claims for expenses incurred while covered, and setting that window explicitly avoids an argument at exactly the moment nobody wants one.
Under IRS Notice 2002-45, an HRA may also reimburse former employees for expenses incurred after they leave, for example up to their remaining balance. At employers with 20 or more employees, an HRA other than a QSEHRA is generally subject to federal continuation coverage, so a departing employee who elects it can keep claiming against the balance.
Dwight SchruteSales3 people
Darryl PhilbinWarehouse1 person
Kelly KapoorCustomer Service1 personHRA vs FSA vs HSA
An HRA is employer money, while a flexible spending account is employee money routed pre-tax. A health savings account is employee-owned and portable, and it requires a specific type of medical plan to exist at all. The three get discussed as alternatives, but functionally they answer different questions.
| Feature | HRA | Health FSA | HSA |
|---|---|---|---|
| Only the employer funds it | |||
| Employee can contribute through payroll | |||
| Employer decides the rollover rules | |||
| Full annual amount available from day one | |||
| Money leaves with the employee | |||
| Can reimburse individual health insurance premiums | |||
| Requires an employer plan document | |||
| Requires a high deductible health plan |
The fourth row is the one employers should read twice. A health FSA obliges you to make the whole annual election available on day one, before the employee has funded any of it, and you absorb the shortfall if they leave. An HRA has no equivalent exposure, because reimbursement is capped by what has actually been made available under the plan terms rather than by an annual election.
The sixth row is the one that decides most small business designs. If the goal is to help people buy coverage rather than to soften the cost of coverage you already provide, only an HRA can do it, and only in its QSEHRA or ICHRA form. Everything else in this comparison is secondary to that.
The three also combine rather than compete. A high deductible plan with a health savings account, plus a limited purpose arrangement for dental and vision, is a common and entirely sensible stack for a small team, and it is worth thinking through alongside the rest of your benefits mix.
How to Set One Up
Setting up an HRA comes down to the seven steps below. For a QSEHRA or an ICHRA, the binding constraint is the 90-day notice rather than anything administrative (26 U.S.C. 9831(d) for a QSEHRA, 26 CFR 54.9802-4(c)(6) for an ICHRA), so start counting backwards from the plan year start date rather than forwards from today.
Almost every decision above gets made once, in a conversation, and then nobody can reconstruct it eleven months later when the notice is due again. Write the answers down while you are making them.
The record-keeping layer under all of this (the plan document, the dated notices, the coverage attestations) is unglamorous, and it is what an audit actually looks at. Keeping it with the rest of the employee file rather than in an inbox somewhere is the part FirstHR is built to carry.
Two of those three items are per-person and dated, which makes them a running sheet rather than a document. If a QSEHRA is the arrangement you land on, that guide carries a log built for the job: notice dates, coverage proof, and each claim against the allowance remaining.
Where Small Employers Get This Wrong
The failures cluster in a narrow band, and most of them start before the first reimbursement is ever paid.
Reimbursing individual premiums without a QSEHRA or an ICHRA is first, because it is the largest. It is the intuitive move, it carries the $100 per day exposure, and there are two legal routes to the same outcome sitting right next to it.
Paying without substantiation is second. It undoes a properly designed arrangement, turning tax-free reimbursement into wages that should have had withholding on them.
Missing the 90-day notice is third, and it is purely a calendar failure. For a QSEHRA it carries its own penalty of $50 per employee, capped at $2,500 a year (IRS Notice 2017-67), and for an ICHRA the notice is one of the conditions the arrangement must meet. Either way, it is entirely avoidable.
Offering an ICHRA and a group plan to the same people is fourth. Employers reach for it because it sounds like choice, and it is not permitted for the same class of employees. Splitting by legitimate class is the compliant version of the same instinct.
Setting an allowance once and never revisiting it is fifth. Premium costs move, the capped figures are indexed annually, and an allowance that was meaningful three years ago quietly becomes a gesture without anyone deciding to make it one. Reviewing it during open enrollment each year takes an hour.
Nick Anisimov, FirstHR founder
Frequently Asked Questions
What is an HRA in simple terms?
An HRA, short for health reimbursement arrangement, is an employer’s promise to pay employees back for qualifying medical costs, and in some versions for the premiums on an individual health insurance policy. The business is the only funder, so employees cannot contribute through payroll the way they can with a flexible spending account. In most designs no money sits in a separate pot: the employer pays each claim once the employee proves the expense, and pays nothing if nobody claims. The employee pays no tax on what comes back, and the company deducts the cost as a business expense.
What are the different types of HRAs?
Five types are in common use, and two of them work alongside a group health plan. The integrated HRA helps with the costs a health plan leaves to the employee, such as deductibles and copays, and it is open only to employees who have group coverage, through your plan or a spouse’s. The excepted benefit HRA is a small, capped allowance offered next to your group plan, and an employee may use it even after turning that plan down. The other three do not need a group plan. A qualified small employer HRA (QSEHRA) is limited to employers with fewer than 50 full-time equivalents and no group plan. An individual coverage HRA (ICHRA) reimburses individual market premiums, and you can offer it at any size, as long as the employees it covers are not also offered your group plan. A retiree HRA is for former employees only.
Can an employer just reimburse an employee for their health insurance?
Not outside a QSEHRA or an ICHRA. If you pay for an employee’s individual market policy, whether by reimbursing them or by paying the insurer yourself, the IRS calls the result an employer payment plan. It counts as a group health plan, and it breaks the federal market reform rules that group plans must meet. The penalty is an excise tax of $100 a day for each affected employee, which adds up to $36,500 per person over a full year. Plain taxable wages with no conditions attached are allowed, since unconditional pay is compensation rather than a health plan, but the tax advantage is gone.
What are the HRA contribution limits?
It depends on the type, because only two of the five carry a federal cap. A QSEHRA is one: for 2026 its ceiling is $6,450 with self-only coverage or $13,100 with family coverage, under IRS Revenue Procedure 2025-32. The other is the excepted benefit HRA, where the amount newly made available for a plan year beginning in 2027 tops out at $2,250, under Revenue Procedure 2026-24. Integrated HRAs, ICHRAs, and retiree HRAs have no federal dollar limit, so the employer chooses the amount. Both caps are indexed for inflation every year, so check the latest figures before you announce an amount to employees.
Does unused HRA money roll over?
It can, if the employer wants it to, and that freedom is a real advantage over a flexible spending account. The plan document sets the rule: carry the whole unused amount into the next plan year, carry part of it, or let it lapse at year end. A QSEHRA limits that freedom, because the carryover and the new year’s allowance combined must stay within that year’s statutory cap. Since most HRAs are unfunded promises rather than funded accounts, a balance carried forward costs the business nothing unless an employee later claims it. Unused money remains the employer’s and never becomes the employee’s property, though a former employee may keep claiming against it through continuation coverage or a plan term that allows it.
Can an employee have an HRA and an HSA?
Only if the HRA is designed not to interfere. A general purpose HRA that reimburses medical expenses before the deductible is met is disqualifying coverage and blocks health savings account eligibility. A limited purpose HRA restricted to dental and vision, or a post-deductible HRA that pays nothing until the statutory minimum deductible is satisfied, is compatible. If anyone on your team contributes to a health savings account, resolve this at the design stage, because the fix afterwards is a plan amendment rather than a conversation.
Is an HRA better than offering group health insurance?
It is a different trade rather than a straight upgrade. A group plan gives employees one negotiated policy and gives you renewal increases you do not control. A QSEHRA or an ICHRA gives you a fixed, predictable budget and gives employees the job of choosing their own policy, which some find liberating and others find stressful. For a business that cannot get a usable small-group quote, or that has employees spread across several states, the reimbursement route is frequently the only realistic option rather than the preferred one.
Do employees pay tax on HRA reimbursements?
No, provided the arrangement is properly structured and the expense is substantiated. Qualifying reimbursements are excluded from the employee’s gross income and are not subject to income tax or payroll tax, and the employer deducts them as a business expense. Two things break that treatment: paying without substantiation, which converts the payment into taxable wages, and reimbursing someone who does not carry the coverage their arrangement requires. Both failures are administrative rather than structural, which is why the substantiation workflow matters more than the plan design.
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