Cafeteria Plans

Cafeteria Plans

By Stacy Wiley, EA

Looking for an easy way to find tax savings for you and your employees? How about a Cafeteria Plan?

A cafeteria plan is a separate written plan, maintained by an employer for employees, which meets the specific requirements and regulations of Section 125 of the Internal Revenue Code. It provides participants an opportunity to receive certain benefits on a pre-tax basis.

The primary reasons for implementing a Section 125 plan are the tax savings for both the employer and employee. Employees’ pre-tax contributions are not subject to federal, state, or social security taxes and the employers save on the employer portion of social security, medicare, federal and state unemployment taxes, and possibly workers’ compensation insurance premiums. This increases the employees’ take-home pay and saves the employer payroll tax expense at the same time.

Employers with cafeteria plans can offer their employees a way to obtain such benefits as health insurance, group-term life insurance, voluntary “supplemental” insurance (dental, vision, cancer, hospital confinement, accident, etc.), flexible spending accounts, and health savings accounts (HSA) through the plan. Most of the plans today are operated through a “salary redirection agreement”, which is a payroll deduction. Deductions under these agreements are called pre-tax deductions.

Under a cafeteria plan, your employees can take advantage of three specific flexible benefits:

  1. Pre-tax health insurance premium deductions, also known as a Premium Only Plan (POP). POP plans allow employees to elect to withhold a portion of their pre-tax salary to pay for their premium contribution for most employer-sponsored health plans. A POP plan is the simplest type of Section 125 plan and requires little maintenance once it’s been set up through your payroll.
  2. Out-of-pocket unreimbursed medical expenses, also known as flexible spending accounts (FSAs). An FSA allows an employee to fund certain medical expenses on a pre-taxed basis through salary reduction to pay for out-of-pocket expenses that aren’t covered by insurance (for example, annual deductibles, office co-payments, prescriptions, and orthodontia). By participating in an FSA, an employee’s taxable income is reduced, which increases the percentage of pay they take home. The benefits are subject to an annual maximum and are subject to an annual “use-or-lose” rule.
  3. Dependent care flexible spending accounts. The dependent care FSA is an attractive benefit for employees who pay for child-care or long-term care for their parents. Many employees don’t take advantage of this benefit and may be unaware of the significant tax savings. Employees may hold back as much as $5,000 annually of their pre-tax salary for dependent care expenses, which include expenses they pay while they work, look for work, or attend school full time.  Qualified dependent care expenses may include, but are not limited to, the care of a child under the age of 13, long-term care for parents, care for a disabled spouse or a dependent incapable of caring for himself, and summer day camps.

Another way to increase tax savings is by using your Cafeteria Plan for your Health Savings Account or HSA. An HSA is an account from which you can withdraw money tax-free for medical care and has higher contribution limits than an FSA. The HSA is also personally owned by each participant or employee. Therefore, they go with an employee when they leave. Deducting HSA savings through a Section 125 Plan (modified to allow HSA deductions), the participant avoids federal, state, and FICA taxes. This method gives the employee a higher tax savings and allows the employer to receive tax savings as well.

The best part about the Section 125 plan is that most of your employees are already paying for these expenses out of their own pockets with after-tax dollars. Cafeteria plans offer them a remarkable way to save money they’re already spending. There are additional rules specific to each benefit and what expenses may be reimbursed and guidelines to the administration of these plans.

One of the best benefits for business owners is that cafeteria plans cost very little to set up and maintain. There are administrative procedures that must be met to comply with Section 125 code legal requirements. A plan document must be established, a summary plan description must be distributed to all participants, and there is ongoing compliance that must be attended to. For most employers, the cost of implementing the plan is recovered through tax savings during the first year–you might even begin saving money as early as the month following the installation of a plan. So what are you waiting for? Now’s the time to act in order to benefit your employees and your business.