The IRS’s ruling in Private Letter Ruling (PLR) 201528004 affords employers several key benefits that should be considered when establishing a retiree health reimbursement arrangement (HRA). Employers can alleviate some of their administrative burden in managing retiree health benefits while generating payroll tax savings on the accumulated unused leave time of retiring employees. Retirees are afforded a broader choice of insurance products, including marketplace options under the Patient Protection and Affordable Care Act (ACA), while minimizing the impact on their retirement savings when paying for postemployment health-care expenditures. Finally, employers are better able to control costs by shifting their focus on funding defined amounts into an HRA plan versus managing the inflationary uncertainties of the health insurance market.


A brief review of the tax law is necessary to understand the operation of HRAs. PLR 201528004 (July 10, 2015) contains a detailed review of the related provisions. Generally, under IRC section 61(a)(1) and Treasury Regulations section 61-21, gross income includes fringe benefits provided in connection with the performance of services. However, IRC section 106(a) excludes from employees’ gross income employer-provided coverage under accident and health plans. The benefits can be provided by paying the premium on the insurance or by contributing to a trust or fund providing the benefits directly or indirectly through insurance.

Revenue Ruling 2005-24 described four types of employer-sponsored employee medical reimbursement plans (see 2002-2 CB 93). Three of the plans resulted in amounts included in the gross income of the employees. One of the situations described in the ruling includes a description of an HRA similar to the one outlined in PLR 201528004. In this arrangement, the employer sets up a reimbursement plan that reimburses employees for medical care expenses that are properly substantiated. The plan applies to both current and retired employees. For a retiring employee, the employer—on a mandatory basis—automatically sets up an HRA upon the employee’s retirement. The employer contributes an amount equal to the retiring employee’s accumulated unused vacation and sick leave. Under no circumstances may the retired employee or that retiree’s spouse or dependents receive any of this amount in cash or other benefits. Revenue Ruling 2005-24 concluded that the reimbursement plan meets the requirements for tax-favored treatment.

Revenue Ruling 2006-36 discussed a similar plan, but this plan provided that, upon the death of the deceased employee’s surviving spouse and last dependent—or upon the death of the employee if there is no surviving spouse or dependent—any unused reimbursement amount would be paid as reimbursement of substantiated medical care expenses of a beneficiary designated by the employee. That plan did not provide amounts excludable from gross income. Amounts paid to an employee under a reimbursement plan are not excludable from gross income if the plan permits amounts to be paid as medical benefits to a designated beneficiary (other than the employee’s spouse or dependents). None of the payments made from the reimbursement plan during the plan year to any person—including amounts paid to reimburse the medical expenses of an employee or the employee’s spouse or dependents—were held to be excludable from the gross income.

HRA Requirements

Based on the tax law described above, the following are requirements for a tax-favored HRA:

  • Employer contributions made to the HRA for retirees, their spouses, and their eligible dependents are not included in the gross income of the employees if the contributions are used exclusively to pay for eligible medical expenses.
  • The employer contributions are not “wages” and are not subject to withholding for Federal Insurance Contributions Act (FICA), federal income taxes, or Federal Unemployment Tax Act (FUTA) purposes.
  • Employer contributions made to a retiree’s HRA for coverage of registered domestic partners are included in the retiree’s gross income.
  • The excise tax under IRC section 4980I is imposed and paid by the HRA.

The Benefits of a Retiree HRA

While a retiree HRA might not suit every company, employers will find some advantages to be very attractive when considering adopting a plan for their respective organization.

A retiree HRA can benefit employers by helping to control the ever-increasing costs of health insurance. Instead of providing a traditional retiree health insurance plan, employers can fund a defined amount into the HRA that the retiree can then use to purchase a health plan—one offered by the employer or one offered in the public marketplace, including supplemental plans that can be utilized with Medicare. This consumer-driven model requires retirees to seek cost-effective solutions for health insurance coverage, alleviating the administrative burden from the employer as well as helping to control benefit costs.

An HRA encourages retirees to fund savings for future medical expenditures, including health insurance premiums. If the employer elects to fund the HRA with mandatory leave time conversions, as outlined under PLR 201528004, the retiree cannot use the funds for any expenditure that does not qualify as a medical expense or insurance premium under IRC section 213. The employer is helping to ensure that the retiree can better afford to retain valuable healthcare coverage, which facilitates access to care, and other ancillary services such as dental, vision, and other supplemental health plans.

Employers can help supplement a retiree’s postemployment income on a tax-free basis by allowing for health insurance premiums and other medical expenditures to be paid for out of funds that do not come from the former employee’s retirement savings. This benefit is amplified because funds inside an HRA can also be invested and grow tax-free, increasing the potential for additional savings for future healthcare expenditures.

Employers can alleviate the administrative burden of having to collect health insurance premiums from retirees by shifting the responsibility to the retiree to fund premium payments directly to the insurer out of their HRA plan.

Retiree HRAs are considered employer-sponsored group plans, thereby meeting the definition of minimum essential coverage under the ACA. As such, covered retirees are not eligible for a premium tax credit that could penalize the employer if the retiree chooses to purchase individual health insurance coverage in the marketplace. This allows retirees to choose healthcare coverage without creating an additional tax burden on the employer.

The favorable tax treatment allowed by the HRA then produces a dual benefit.

As allowed under Revenue Ruling 2005-24, employers may also elect to have a retiree’s unused vacation leave time—which is normally paid out as a payroll expense—mandatorily converted into a retiree HRA (see 2005-1 CB 892). The favorable tax treatment allowed by the HRA then produces a dual benefit: the retiree is able to fund more into the HRA by avoiding FICA and federal income taxes under IRC sections 105(b) and 106, while the employer is afforded a similar tax break on FICA as well as FUTA payroll taxes. An employer is still able to deduct the final vacation payout as an ordinary business expense under IRC section 162.

Due to the positive federal income tax and payroll tax treatment of employer contributions to retirees’ HRAs, as described in PLR 201528004, these arrangements can be a valuable benefit. Employers should consider implementing HRAs for their retiring employees.

David W. Clark, CPA is an instructor of accounting and healthcare management, and.
Darlene Pulliam, PhD, CPA is the Regents Professor and McCray Professor of Business, both at West Texas A&M University, Canyon, Tex.