What is a Section 125 Cafeteria Plan?

Section 125 Cafeteria Plan

A Section 125 Cafeteria Plan, also known as my cafeteria plan, is an employer-sponsored benefits plan that lets employees pay for certain qualified medical expenses – such as health insurance premiums – on a pre-tax basis. It’s called a “cafeteria plan” because, like walking through a cafeteria and selecting various dishes to eat, employees can choose the types of healthcare options they want, such as medical, dental, vision and other benefits, and decline the ones they don’t.

In addition to the health benefits, employees may enjoy lower taxes. Contributions to the cafeteria plan are made before taxes are taken out of their paychecks. For employers, they pay less since employees only select the benefits they want rather than the whole spectrum of offerings.

The primary advantage to employees is the range of healthcare options that allows them to use Section 125 money to fit their needs. Typically, they can use the pre-tax money to pay for health insurance premiums, retirement deposits, or other benefit options. If they don’t want any of the offered benefits, they may be able to choose alternatives including cash suplemental life or disability insurance.

It’s important to note that a Section 125 Cafeteria Plan does not provide health insurance. Instead, it allows employees to use pre-tax money to choose and pay for the types of insurance coverages that are most meaningful to them.

Section 125 Cafeteria Plan Requirements

To qualify as a Cafeteria Plan, the plan must include:

  • At least one taxable benefit option, considered part of the employee’s salary, and
  • At least one qualified pre-tax benefit

An example of the taxable benefit option could be allowing employees to take the monthly amount as part of their salary rather than applying it towards the benefit plan. With traditional company-sponsored healthcare insurance, the employer generally pays part of each employee’s premiums. If an employee opts out of the plan, he or she does not receive compensation for the amount their premiums would have cost. With a Section 125 Cafeteria Plan, however, the employer may choose in this situation to offer the cost of the benefits as cash. The employee may use the money towards another benefit. Although, if the employee receives cash, that money is taxed.

Qualified pre-tax benefits can range from health and disability insurance to Flexible Spending Accounts (FSAs), Dependent Care Assistance Plans (DCAP), Health Savings Accounts (HSAs), and contributions toward retirement plans.

The Big Three Benefit Accounts for Employees

The following Section 125 Cafeteria Plan features offer employees significant tax and money-saving advantages:

  1. Flexible Spending Accounts (FSAs). An FSA allows employees to pay for qualified out-of-pocket medical expenses on a pre-tax basis. If the FSA is the only benefit provided, employees may use the account to cover health insurance premiums.
  2. Health Savings Accounts (HSAs). Like an FSA, HSAs enable people to set aside pre-tax money for a wide variety of approved healthcare products and services. Unlike with FSAs, employees own the account and can take it with them anywhere they go.
  3. Dependent Care Assistance Plan (DCAP) FSAs. A DCAP allows employees to set aside up to $5,000 a year pre-tax to pay for dependent care services. This allows working parents the ability to save on child care while they are at work or attending school.

Benefits to Employers

Section 125 Cafeteria Plans also provide several important advantages to employers, especially those who own a small business.

Section 125 cafeteria plans vary depending on the employer’s needs. They can also be fairly complicated to put together and administer. The plans lock employees into their designated contributions for a full year. With few exceptions, employees must wait until the following enrollment season to make plan changes. If employees don’t use all their FSA money in the calendar year, they can only roll over a maximum of $550 to the next year. Also, unused FSA money may be forfeited if their employment status changes.

A section 125 cafeteria plan offers a cost-effective benefits plan for companies. It can help businesses save money while keeping employees happy.  Due to the complexity of these plans and their compliance issues, contact a benefits administration professional who specializes in creating and administering these types of plans.

DataPath, Inc. is a leading provider of technology solutions for cloud-based benefits administration.

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