New Cachet for Health Reimbursement Accounts

Both employers and retirees like the flexibility that HRAs provide.

By Martha Lynn Craver, Associate Editor, The Kiplinger Letter

December 27, 2007

Look for more employers and workers to go for health reimbursement arrangements (HRAs) to replace traditional retiree health care benefits. HRAs are funded entirely by the employer. Money in the accounts is never taxed -- it accumulates tax free. Distributions are also tax free, as long as they are used to pay for qualified medical expenses.

Employers like HRAs because they offer a flexible middle ground. While many companies have moved in recent years to eliminate retiree health coverage altogether, others are looking for a way to retain some kind of benefit, which can be a powerful recruiting and retention tool. HRAs may be the answer for companies that don't want an open-ended commitment. "Employers want predictability and control over their costs," says Rick McGill of Hewitt Associates, a benefits consulting firm.

Another attraction for employers is that HRAs are notional accounts, which means that employers don't incur any expenses until a retiree has a claim, says David Speier, a consultant with Watson Wyatt Worldwide. That's a big bookkeeping aid. And it has advantages over the other popular method of controlling costs, which is to put caps on premium contributions for retiree health care. Of firms that still provide retiree medical coverage, about half have instituted limits on what they will spend per retiree, according to a survey by the Kaiser Family Foundation. And of those, about 60% have reached their caps, which means that retirees pay a bigger share of the premiums as time goes on. In the next three years, an additional 23% of firms will hit their caps.

Employers may choose to put lump sums in HRAs at retirement or make annual contributions to these accounts either during or after retirement. Because employers have control over vesting and payout rules with an HRA, they may allow an active worker's HRA, with accumulated funds, to carry over into his or her retirement.

HRAs provide flexibility to retirees as well. For example, some retirees may choose to use the money to pay for medical coverage until age 65, when Medicare kicks in. Any funds left over could then be used to pay for a Medicare supplemental insurance plan and Medicare Part D drug coverage. Retirees with coverage through their spouses can let their HRA funds sit and grow, not tapping them until they both join the ranks of the retired.

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