Offering Wage Increases for Health Coverage vs. ICHRA

Written by Elizabeth Walker | Apr 22, 2026 5:00:00 PM

To save on healthcare costs and time-consuming administrative tasks, some employers are turning to informal health benefits. One common method is to increase employees’ wages so they can pay for their own medical expenses. While this seems like a simple option, it often comes with hidden costs and compliance risks.

Fortunately, the individual coverage health reimbursement arrangement (ICHRA) gives employers a flexible, cost-controlled way to provide their staff with a formal employee health benefit, without the hassle or administrative complexity.

This article will walk you through how wage increases for health coverage compare to the ICHRA, so you can understand the key differences and make the right choice for your business.

In this blog post, you’ll learn:

How offering employees a wage increase for health insurance works, including its pros and cons.

How an ICHRA works and how it benefits both employers and employees.

The main differences between wage increases and ICHRAs, and which one is a better long-term employee benefit strategy.

What is a wage increase for health insurance coverage?

A wage increase for health coverage is an informal health benefit where an employer raises an employee’s salary or hourly pay to help them pay for their healthcare expenses. Instead of offering a formal health benefit, employees receive extra income added to their normal paycheck, which they can then use on monthly health insurance premiums and other medical costs.

Below are a few benefits of offering wage increases:

Similar to a health stipend, wage increases are simple to implement and require little to no administrative setup.
There are no plan documents, compliance requirements, or additional reporting obligations for wage increases.
Employees have complete control over how they want to use their extra income.
Employers can adjust the amount of the increase based on budget or overall goals.
There’s no need to manage open enrollment, reimbursements, or ongoing benefit administration.

While these advantages may seem enticing, wage increases are often the least efficient way to give your employees a health benefit. Salary increases are subject to federal and state income taxes as well as payroll taxes. This means the employer and employees pay more in taxes, reducing the amount of money available for healthcare costs.

Wage increases also don’t meet the coverage requirements under the Affordable Care Act (ACA). For applicable large employers (ALEs), increasing pay doesn’t count as offering affordable or minimum value coverage, which can leave you facing adverse tax consequences, including the employer shared responsibility provisions (ESRP) penalties ¹.

The federal government may also consider some wage increases for health coverage as an employer payment plan. IRS Notice 2013-54 notes that any arrangements considered an employer payment plan fail to comply with the ACA. This may make employers liable for excise taxes under Code § 4980D. However, if the wage increase can be freely used for any purpose, including non-medical coverage, it doesn’t constitute an employer payment plan.²

Lastly, there’s no guarantee employees will use their wage increases on medical care or health services. If they decide to use the money to pay for other expenses — such as rent, childcare, or other bills — they may not have enough leftover to pay for health insurance premiums or medical emergencies. This may make your wage increase not feel like a true health benefit.

What is an ICHRA?

An ICHRA is a defined-contribution approach to employer-sponsored health benefits. Rather than offering a traditional group health plan or adding extra money to their paychecks, employers provide their W-2 employees with a set monthly allowance to purchase their own individual health insurance coverage.

Employees select the health plan that works for them on the individual marketplace. Then, they use the employer’s contribution to pay their monthly premium. If your plan design allows it, other out-of-pocket medical expenses may also be eligible costs. In either case, employees must have a qualified individual health plan that meets minimum essential coverage (MEC) requirements to use the benefit.

ICHRAs have grown in popularity due to the following customization options and advantages:

Employers can contribute any amount of money that fits their budget. There are no minimum or maximum contribution limits.
A defined contribution employee benefit means your budget costs are always predictable, eliminating the surprise of annual renewal increases.
Employers can tailor eligibility and allowance amounts by employee classes, as well as adjust contributions based on age or family size.
Employees can’t exceed their set monthly allowance, and any unused funds remain with you at the end of the plan year or when an employee leaves your organization.
ICHRA contributions are tax-deductible for employers and exempt from payroll taxes, while employees’ allowances and payments are income tax-free.
The ICHRA benefit doesn’t transfer with the employee if they change jobs. However, they can keep their individual health insurance coverage, as it’s not tied to employment.

Wage increases vs. ICHRA comparison chart

The chart below compares the main differences between wage increases and ICHRAs.

	Wage increases	ICHRA
How does the employee benefit work?	A wage increase gives employees additional taxable income through their paycheck, with the intended purpose of them spending the funds on medical care.	An ICHRA provides employees with a defined, tax-free monthly allowance that they use to buy eligible medical expenses.
Does the benefit only support healthcare costs?	Sometimes, if offered as a health stipend. However, these arrangements fail to satisfy the ACA, potentially resulting in excise taxes and penalties. However, with a regular wage increase, employees can use their wage increase dollars to pay for any expense, not just health services.	Yes, employees can only spend their ICHRA funds on qualified medical costs, including health insurance premiums.
What are the tax implications?	Wage increases are subject to income taxes for employees and payroll taxes for employers. If the increase is offered as an employer payment plan, organizations may also be subjected to excise taxes and penalties.	Contributions are tax-deductible and free of payroll taxes for employers. ICHRA payments are also free from income taxes for employees.
Is the benefit cost-effective for employees?	Wage increases are less cost-efficient because, as paycheck additions, a portion of the increases will be subject to taxes before employees can spend the funds.	The ICHRA is a pre-tax health benefit, meaning contributions are deducted from employees’ gross pay before taxes. This means employees get access to their full benefit funds. With off-exchange individual plans, employees can also pay for any premium amounts not covered by ICHRA through pre-tax payroll deductions.
What is the level of cost control for employers?	Employers have less control over long-term costs because wage increases add up over time without the guarantee that employees are using their extra money as intended.	The ICHRA offers greater cost control. The benefit has no minimum or maximum contribution limits, meaning employers can choose their preferred allowance and adjust the amount during renewal. Employers can vary contributions by employee classes, family size, or age for greater flexibility.
Does this option meet the ACA’s employer mandate requirements?	No, wage increases don’t count as offering a formal benefit; therefore, they don’t satisfy the ACA’s employer mandate requirements. ALEs may face penalties if they rely on wage increases instead of offering compliant health coverage.	Yes, ALEs can use the ICHRA to satisfy the employer mandate requirements and avoid ACA penalties as long as they offer it to at least 95% of their full-time workers and their dependents. The benefit’s allowance must also be affordable.
How much choice do employees have?	Employees have complete flexibility with a wage increase, but that may not mean that they’ll choose to spend their funds on medical care.	Unlike group health plans, employees can select the individual health coverage that best fits their needs, helping to ensure the best possible health outcomes.
Is the benefit portable for employees?	A wage increase is part of an employee’s compensation. If they use the extra money to buy individual health insurance coverage, they can keep the policy if they leave their job, as long as they keep paying the premium.	Employees own their individual health insurance coverage and can keep their plan if they leave the company (as long as they continue paying the premium). However, unused ICHRA funds stay with the employer. ICHRA is subject to COBRA, but employees typically don’t elect COBRA due to the cost.
What is the administrative burden?	Taxable wage increases require very little administration since employers simply add the extra funds to employees’ regular paychecks and process them through payroll.	An HRA administrator, like Remodel Health, can keep the benefit hassle-free. We help with onboarding, making premium payments, generating reports, and simplifying daily tasks so you have more free time. If you’re an ALE, we’ll design your benefit and provide support so you meet the ICHRA compliance regulations and avoid penalties.

Why is an ICHRA a better option than a wage increase for employees’ health coverage?

While wage increases may seem like an easy solution, they come with risks for you and potential frustrations for your staff.

ICHRAs are a more sustainable employee health benefit compared to wage increases due to the following reasons:

With an ICHRA, employer contributions go further because they’re exempt from payroll and income taxes. Employees receive the full value of their ICHRA benefit, and employers avoid extra tax liability.
An ICHRA guarantees that employees only spend funds on healthcare costs. Unlike a wage increase, which employees can use on any expenses they want, employees can only use ICHRA contributions for health insurance premiums and qualified medical expenses outlined in IRS Publication 502 ³ and the CARES Act⁴. For greater cost control, most employers choose to limit eligible expenses to premiums only.
Instead of group health plan rate renewals or increasing wages every year for medical care, employers can set and adjust contribution amounts based on their budget, using employee classes as well as age and family size variations. This level of control and customization options makes long-term planning easier.
According to federal legislation, ALEs can compliantly design their ICHRA to meet ACA employer mandate requirements and avoid penalties, which is something a wage increase can’t provide.
The ICHRA allows employees to select the health coverage that best fits their personal needs, whether that’s a lower monthly premium, a broader network, or specific providers.

Conclusion

Increasing wages can feel like a good way to help employees with their medical care, without getting a group plan. However, don’t be surprised when this strategy falls short in the long run. Because of their tax implications, compliance risks, and the lack of oversight on how employees may spend their extra money, wage increases bring more challenges than they solve.

In contrast, an ICHRA gives employers cost control, tax advantages, and visibility, all while empowering employees to choose their own health coverage. If you think the ICHRA is the right solution for you in today’s tough job market, Remodel Health is here to help you design, implement, and administer your employee health benefit. Contact us today to get started!

This blog article was originally published on June 9, 2020. It was last updated on April 22, 2026.

References

1. IRS Rev. Proc. 2025-26

2. IRS Notice 2015-17

3. IRS Publication 502

4. CARES Act

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