Section 125 Cafeteria Plans

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Cafeteria plans, better known as flexible benefits plans or Section 125 plans, offer more control over benefits – allowing employees to pick and choose a variety of options and coverage levels. Many employers offer Cafeteria plans because of the ability to customize benefits and save money. A cafeteria plan can create sizable savings for both parties by removing the much of the tax liability.

The written plan must specifically describe all benefits and establish rules for eligibility and elections.

How it works:

A cafeteria plan allows participants to select certain benefits on a pretax basis. Participants in a cafeteria plan must be permitted to choose among, at minimum, one taxable benefit (such as cash) and one qualified benefit.

A qualified benefit does not defer compensation and is excludable from an employee’s gross income. Qualified benefits can include:

• Accident and health benefits
• Dependent care assistance
• Group-term life insurance coverage
• Flexible Spending Accounts (FSAs)

Employee Benefits:

During enrollment, employees can select the specific benefits they desire, at the available level of coverage they desire. This, in turn, reduces taxes for the employee because pretax contributions for premiums or FSAs are not subject to federal, state, or Social Security taxes.

Employer Benefits:

Employers can use cafeteria plans to help promote specific health plans, attract new employees or create savings for their employees. Another employer benefit results from every dollar an employee puts into a FSA being one less the employer must pay taxes on.

Maximize Savings by Keeping These Points in Mind:
Cafeteria plans can be a win-win for employers and employees alike, but however, there are a few things to be aware of.

• Social Security: Any funds in an FSA are tax-free, which may result in lower Social Security income at retirement. However, the savings created by using an FSA are usually greater than the relatively minor dip experienced at retirement.
• Forfeiture Rule (Use it or lose it): Any funds left over in an FSA at the end of the year cannot be rolled over to the following year’s account. This is easily avoided by carefully estimating the amount to fund when enrolling.
• Employer liability: Avoid loss of funds due to terminations
• Dependent Care: Dependent care account expenses cannot be recovered through the childcare tax credit. But the savings from using the account is generally more than a participant recovers through other means. Employees should discuss how to best optimize this with a tax expert before enrolling.
• Employers must maintain strict paperwork, including a written plan document, filing proper tax returns and maintaining an up-to-date Form 5500. Employers may not discriminate between regular and “highly compensated” employees when offering a cafeteria plan and must routinely test for such discrimination.
• There is an IRS permitted grace period, and employers may elect to offer a run-out period in addition to this, which extends period for filing claims and/or using funds beyond the plan year. Claims submitted during these extended periods must be for services incurred during that plan year.