As we barrel toward October, both you and your employees may be thinking about company benefits. One of the most overlooked options for small businesses is a section 125 Cafeteria Plan. Cafeteria plans are widely misunderstood, perhaps because of their name, but they’re important because they can be a great way for a small business to offer health, dental, and insurance benefits while getting a tax break.
What is a Cafeteria Plan?
A Cafeteria Plan is a reimbursement plan governed by IRS Section 125 which allows employees to contribute a certain amount of their gross income to a designated account (or accounts) pre-tax. The easiest way to think of a cafeteria plan is to think of it like a menu (hence the name) from which your employees can choose between medical, dental, vision, and other benefits, or opt to receive the same amount in cash. To be legal, a cafeteria plan must meet specific requirements of Section 125 of the Internal Revenue Code:
- The plan’s benefits are offered a pre-tax basis, meaning employees can pay their health premiums, retirement deposits, or other benefit options using non-taxed wages through their employer’s section 125 reimbursement account.
- The plan has to include at least one taxable benefit option, which means the government views it as part of the employee’s salary. An example of this is allowing employees to instead take the monthly amount as cash into their salary (over using it towards the benefit plan).
- The plan also must include at least one qualified benefit, which means it is excludable from an employee’s gross income under a specific provision of tax law, meaning it is pre-tax. Qualified benefits include:
- Accident and health benefits, like health insurance and disability insurance
- Dependent care assistance (from a dependent care FSA)
- Health savings accounts (HSA)
- Retirement Plans (401K or IRA, etc.)
The most important aspect of a cafeteria plan is ensuring that employees receive the same amount allocated to them, regardless of whether they apply it towards health-related benefits (pre-tax) or receive it as part of their taxable wages, such as by cash or other taxable benefits like life insurance or supplemental disability.
The most common cafeteria plans are your standard medical, dental, vision insurance plans that are traditionally thought of as employer-sponsored health insurance plans. But let’s be clear: A cafeteria plan is NOT providing health insurance. What’s the difference? In a traditional insurance employer-provided insurance plan, the employer covers all (or part) of employee premiums. If an employee decides opts out of health insurance — because they’re already covered by a spouse’s plan — they do not get the allocated amount put towards other benefits, or towards their own salary as cash. It just disappears. By contrast, with a section 125 cafeteria plan, the employee that opts out of health insurance can receive the dollar amount as cash, or use it towards another benefit. Just remember, if they opt for cash, the amount will be taxed at the employee’s usual salary rate.
Advantages vs. Drawbacks
As an employer, the main advantage to having a cafeteria plan is tax savings. As your employees’ taxable wages are lowered, your payroll taxes lower. FICA, FUTA, SUTA, and Workers’ Compensation rates are all reduced. With those savings in your pocket, the cost of setting up a cafeteria plan is reduced. In addition, you, as the employer, get to keep the money that’s not used in FSAs at the end of each year. Again, more savings and cost reduction.
Second, though not unimportant, is the fact that employees really love cafeteria plans. Those who need the health or other insurance benefits are grateful for the coverage. Those who don’t are grateful for the cash. Everyone wins, and it’s been our experience that cafeteria plans reduce turnover and help attract new talent.
The downside to cafeteria plans? There are mainly two for employers. The first is that there is an initial set-up fee involved. In the long run, it should be offset by your savings, but it’s a consideration up front. Second, they can be pretty complicated to set-up. The paperwork is intense as details and subtle nuances (most not even mentioned here) must be satisfied. We always recommend that employers work with professional on how to effectively set up their plans. Non-compliance can be costly. A qualified insurance broker can ensure your Section 125 plan is compliant.
Establishing an employee benefits program can be difficult for the small business owner, and cafeteria plans are worth considering. Feel free to reach out to us for more assistance.
