Why Employers Should Offer HRAs vs Giving Raises

1. The employer pays taxes on the raise. An annual raise of $300 per month gross actually costs the employer $322.95 per month when you factor in payroll taxes (7.65%). In other words, the employer is spending $3,875.40 in order to offer a pre-tax raise of $3,600.  
2. The employees pay taxes on the raise. Assuming the employee is 1) single and 2) making $35,000+, the employee must pay $1,175.40 of the $3,600 in taxes ($3,600 * 32.65%*). In other words, the employer is spending $3,875.40 in order to offer an after-tax ("take home") raise of $2,424.60.  
3. Extra income is typically spent on consumer goods. It is unlikely that the salary increase will be put towards the purchase of health insurance.  

With a health reimbursement arrangement (HRA), the company gives each employee a fixed dollar HRA allowance the employees choose how to spend. Employees then use their HRA to reimburse themselves for out-of-pocket health insurance costs or other medical expenses 100% tax-free.

The reimbursements are:

1. Tax deductible to the business
2. 100% tax-free to employees

As a result, $1 in an HRA may be worth $1.50 - $2.00 in a taxable raise depending on the employee's tax bracket.

Additionally, the $1 in HRA costs the company less than a $1 raise. (Remember, it's tax deductible to the business so the company does not have to pay payroll taxes!)

Here's how it works:

1. The business sets the HRA allowances (the allowances can be varied based on employee job classifications, and there is no "minimum contribution")
2. The business decides what expenses can be reimbursed by the HRA (eligible expenses include health insurance premiums, dental expenses, doctor visits, etc.)
3. The business decides who is eligible for the HRA (the employer can restrict eligibility based on job classifications, and there is no "minimum participation")