Affordability Safe Harbors: Which One Is Best for You?

Affordability Safe Harbors: Which One Is Best for You?

This article was updated on July 12, 2018.

The Affordable Care Act (ACA) requires large employers to offer affordable, minimum value health insurance to their full-time employees in order to avoid potential penalties under the shared responsibility provision, according to the IRS. In 2019, affordable coverage is defined as costing the employee no more than 9.86 percent of household income for self-only coverage under the lowest-cost plan you offer. This percentage is indexed for inflation annually.

Employers don't have access to their employees' household incomes, so the IRS offers three optional safe harbors that you can use to ensure the coverage you're offering is considered affordable. You can use the same safe harbor for all employees or you can use multiple safe harbor methods, as long as the same method is applied consistently across all employees in a reasonable category.

And while we may see changes to health care policy this upcoming year, until the law changes, employers need to comply. With that in mind, here's how to determine which safe harbor makes the most sense for your organization.

W-2 Wages Safe Harbor

The W-2 wages safe harbor is based on ensuring that the employee's premium doesn't exceed 9.86 percent of the employee's W-2 wages. Under the W-2 wages safe harbor, the employee's premium contribution must be consistent throughout the year, either as a dollar amount or a percentage of W-2 wages. Employers can't make adjustments to offset a reduction in pay, despite the fact that the final determination of affordability under this safe harbor method is calculated at the end of the year (when the total W-2 wages for the year and total employee contributions for health insurance are known).

Organizations can set employees' premium contribution as a specific percentage of W-2 wages for each pay period, so that by the end of the year, total contributions haven't exceeded the affordability threshold. That would mean, however, that the dollar amount of an employee's premium contribution could vary from one month to the next, which employees might find confusing.

The W-2 wages safe harbor tends to be best suited for situations where employees have very predictable earnings throughout the year, particularly if they work 40 or more hours per week.

Rate of Pay Safe Harbor

To use the rate of pay safe harbor for hourly employees, you take the lower of their hourly pay rate on the first day of the coverage period (typically the plan year), or the lowest hourly rate of pay they earned during the calendar month, and multiply it by 130 (regardless of the number of hours they actually work).

If hourly employees have unpaid leave or reduced hours during the month, they can still be required to contribute up to 9.86 percent of their lowest hourly rate of pay multiplied by 130. On the other hand, if their hourly rate of pay is decreased, you must calculate a new required premium cap for that month. If an employee gets a raise to a higher hourly rate mid-year, you'd still use the hourly rate as of the first day of the plan year. For salaried employees, the employee's premium contribution can't be more than 9.86 percent of their monthly salary. This safe harbor can't be used for salaried employees if their monthly salary is reduced during the year.

The rate of pay safe harbor can't be used for employees who receive tips or whose pay is based solely on commissions. Otherwise, it's a good choice for organizations that have a workforce with hours that vary from one month to the next, since fluctuating hours won't impact the affordability calculations for a given month. Unlike the W-2 wages safe harbor, an employee's pre-tax salary reductions don't impact the calculation.

Federal Poverty Level Safe Harbor

This is the easiest of the three safe harbors to use, and may be a good choice if you have a large seasonal or variable-hour workforce for whom you're using the look-back method of determining eligibility for coverage. But it also tends to result in the lowest allowable employee premium contribution (unless you have workers earning the federal minimum wage, in which case the rate of pay safe harbor currently results in a slightly lower contribution).

The calculation is simple — you take the federal poverty level for one person, divide it by 12, and the employee's monthly premium contribution can't be more than 9.86 percent of that amount.

Employers can use the federal poverty level that was in effect six months prior to the start of the plan year. You'll have the same maximum allowable contribution for each employee in the category for which you're using the federal poverty level safe harbor, and since you can use the same federal poverty level throughout the plan year, you only have to do the calculation once. If your organization is generous with benefits and requires very low employee contributions anyway, this method is very simple to administer.

As an HR leader, know the requirements for safe harbors that the IRS allows for determining if your organization provides minimum essential health coverage under the ACA. Then you can determine which safe harbor makes the most sense for your organization.