Defined Contribution Allowance: ICHRA Rules for 2026

TLDR

An Individual Coverage Health Reimbursement Arrangement (ICHRA) operates entirely on defined-contribution allowances. Employers set a fixed, tax-free dollar amount per employee class, giving businesses complete budget control while allowing employees to choose their own individual health plans. Unlike traditional group plans with volatile annual rate hikes, or QSEHRAs which cap contributions at statutory limits ($6,450 individual / $13,100 family in 2026/2027), an ICHRA has no federal minimum or maximum contribution cap. Setting allowances strategically requires balancing cost predictability, employee choice, and ACA affordability standards.

What Is a Defined-Contribution Allowance in an ICHRA?

In a defined-benefit health plan (like traditional group insurance), the employer promises a specific benefit package and absorbs whatever premium increase the insurance carrier demands at renewal. In a defined-contribution health plan (like an ICHRA), the employer promises a specific dollar allowance, and the employee chooses the policy that best matches their clinical needs and budget.

Under IRS and Department of Labor rules, ICHRA defined-contribution allowances are:

• Solely Employer-Funded: Employees cannot contribute to the HRA account via salary reduction, although they may use Section 125 cafeteria plans to pay the employee-paid premium difference for off-exchange policies.
• 100% Tax-Free: Reimbursements for qualified medical expenses and individual health insurance premiums are exempt from federal income, state income, and FICA payroll taxes.
• Class-Customizable: Employers can designate different allowance amounts across up to 11 legally recognized employee classes.
• Uncapped: There are no statutory annual maximums or minimums imposed by the IRS.

How to Set Compliant Allowance Amounts

While employers have immense flexibility, allowances must adhere to four key compliance guardrails:

1. The Same Terms Requirement Within Classes

All employees within a designated class must receive the exact same allowance on the same terms, except for permitted age and family-size scaling. You cannot offer different allowances based on performance, tenure, or individual health status.

2. Age-Based Scaling Rules

Employers may increase allowance amounts for older employees to account for higher individual health insurance premiums. However, the maximum allowance offered to the oldest employee cannot exceed 3 times the allowance offered to the youngest employee within the same class (a 3:1 age ratio).

3. Family-Size Scaling

Employers may establish tiered allowances based on family status (e.g., employee-only, employee + spouse, employee + children, or family coverage). The multiplier must be applied uniformly across the class.

4. ACA Affordability Safe Harbors (For ALEs)

Applicable Large Employers (ALEs) with 50 or more full-time equivalent employees must ensure their defined-contribution allowance is considered affordable under Section 4980H. The required employee contribution for the Lowest Cost Silver Plan (LCSP) in their rating area cannot exceed the annual affordability percentage (9.96% in 2026, and 10.22% for plan years beginning in 2027, per IRS Rev. Proc. 2026-26) under an approved safe harbor (W-2, Rate of Pay, or Federal Poverty Line).

Common Allowance Pitfalls to Avoid

• Treating the allowance as cash. Under an HRA, the allowance is a reimbursement ceiling, not a cash wage increase. Unused funds cannot be paid out as taxable cash.
• Stacking an affordable ICHRA with premium tax credits. Employees offered an affordable ICHRA cannot receive Marketplace premium tax credits (PTCs).
• Forgetting the affordability percentage changes yearly. It was 9.02% in 2025 and 9.96% in 2026 (and 10.22% for plan years beginning in 2027, per IRS Rev. Proc. 2026-26). Using an outdated percentage can lead to Section 4980H penalties.
• Setting flat national allowances across diverse geographies. Individual health insurance rates vary widely between states and counties. A $350 allowance might cover 80% of a premium in Texas but only 45% in New York. Align allowances with local benchmark Silver plan costs.

Automating Allowance Administration with SimplyHRA

SimplyHRA eliminates the guesswork in defined-contribution plan design. Our platform provides automated affordability modeling across every US rating area, seamless ERISA plan document generation, and universal payroll deduction files.

Book a live demo today to design a compliant, cost-effective ICHRA allowance structure for your company.