A Cafeteria Plan functions through a simple yet effective mechanism known as salary reduction agreements. Employees elect to receive their compensation as a lower cash salary but are then given the equivalent value to spend on a range of benefit options provided by the plan. In a sense, employees divert a portion of their gross income to pay for their chosen benefits before taxes are applied, resulting in tax savings both for them and the employer. Introduced in the 1970s, modern cafeteria plans cover several types of elective benefits, the most common of which include medical, dental, and vision insurance, as well as flexible spending accounts (FSAs).
Types of Section 125 Plans
As the name implies, these premiums are the only expense that the funds can cover. The premiums can be for employer-sponsored insurance plans or individual health policies. A premium-only plan (POP) allows employees to pay their portion of insurance on a pretax basis. The flexible spending account (FSA) version allows for out-of-pocket qualified expenses to be paid pre-tax.
Simple Cafeteria Plans
And with a section 125 plan, there are other employers’ perks to take into account. These circumstances do not suffice in and of themselves to support a special open enrollment. Employees typically need to show proof of their eligibility in the form of a marriage licence, birth certificate, letter from an insurance company, or other legal document. Anyone participating in the plan can typically anticipate saving 20% – 40% of each and every dollar invested in the plan. During open enrollment, you specify that you want to put $3,050 (the maximum amount allowed in 2023) in your FSA for the year.
Cafeteria plan benefits
In the new plan year, the full amount you elected to withhold for the year is deposited into your account by the employer; the employer essentially fronts the account money for the next year. The following is a list of common non-prescription over-the-counter items eligible for reimbursement, dual purpose items that may be reimbursable with a physician’s statement and items that are not reimbursable. Thomas J Catalano is a CFP and Registered Investment Adviser with the state of South Carolina, where he launched his own financial advisory firm in 2018.
A section 125 cafeteria plan (or, simply – cafeteria plan) applies to a kind of employee benefits program. In this scenario, an employer grants employees a couple of different taxable and non-taxable benefits. It is then up to the employee to choose which perks would suit their personal needs. A cafeteria plan is a type of benefit plan offered by employers that allows employees to choose between taxable and non-taxable benefits.
Frequently asked questions about section 125 plans
Any plan that qualifies under IRC section 125 and gives employees the option to choose from at least one taxable benefit and one qualified benefit may be considered a cafeteria plan. POP, or premium only plans, meet this criteria, which means they are a type of cafeteria plan – one that allows employees to pay only their share of insurance premiums via pretax payroll deductions. The out-of-pocket eligible expenditures can be paid pre tax under the flexible spending account (FSA) version, which is the design of the above-described plan. This plan allows employees to contribute pre-tax dollars into a flexible spending account (FSA), which can be used to pay for qualified medical expenses, dependent care expenses, or commuter expenses. A cafeteria plan is a cafeteria plan voluntary benefits program allowing employees to choose from various benefits, such as health and dental insurance, retirement plans, and flexible spending accounts.
Are You Retirement Ready?
Plans normally include options such as insurance benefits and benefits that help with various life events such as adoption. A cafeteria plan is also referred to as a flexible benefits plan or Section 125 plan. A health care flexible spending account (FSA) is an example of a benefit offered under a cafeteria plan.
The money in this account is to be used only for qualified expenses and must only be used within the plan year. You’ll be able to be reimbursed throughout the year from this plan for any qualifying expenses. Keep in mind that you can only change your election if you have a qualifying life circumstance. Qualifying circumstances can include marriage, divorce, or a change in employment. The following is a list of over-the-counter items the IRS has determined to be primarily for medical care and eligible for reimbursement.
- Benefits that are not subject to taxation include retirement contributions and insurance alternatives.
- Most employee benefit plans are covered by the Employee Retirement Income Security Act (ERISA) and must also furnish a summary plan description (SPD).
- In principle, Section 125 plans are designed to prevent any type of deferment of employee income or compensation except through a 401(k) or other types of qualified retirement savings plan.
- Cafeteria plans allow employees to choose their benefits from a pool of options.
- Such as adoption aid benefits or group life insurance payouts that exceed $50,000.
The employee’s share of the cost is made through pretax payroll deductions. Without a Section 125 plan, employee contributions can only be made with after-tax dollars. Because employees can select their own benefits from a cafeteria plan, what is covered will be different for each person. What you choose from a cafeteria plan will depend on your personal needs, any family or children you may have who also need to be covered, and how close you are to retirement. Popular choices include things like a 401(k), life insurance, health savings account, disability insurance, adoption assistance, and more.
- The employee should add a certain amount of cash into the account each year, up to a maximum limit.
- Before taxes are paid, these perks may be taken out of the paycheck of an employee.
- If a change in status does occur, the election changes should be consistent with that event.
- To comply with the IRC, employers must offer their employees at least one taxable and one non-taxable (aka qualified) benefit.
- This can partly be rectified by only allowing benefits to be changed periodically.
- Let’s dive into the details of this adaptable benefits program that both employees and employers should become well-acquainted with.
The «election» amount is deducted from the employee’s paycheck automatically for each payroll period. Employers do not have to allow employees to make midyear election changes except those under the HIPAA special enrollment rights. An employer should include in the plan documents and summary plan description information about which events, if any, would allow for an employee to make midyear election changes.