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  Home  >  Employee Group Benefits  >  Cafeteria Plans

What is a Section 125 Cafeteria Plan?

As its name suggests, under section 125, a cafeteria plan allows an employee to choose where his or her benefit dollars will be spent. The plan can provide a number of selections, including medical, accident, disability, vision, dental and group term life insurance. It can also reimburse actual medical expenses and it can pay children’s daycare expenses. It does these things with pre-tax dollars, which is a huge savings for the employee.

These benefits must be funded with tomorrow’s earnings, not yesterday’s. Each person must estimate the costs that he or she will incur during the plan’s upcoming year and request to have the estimated amount redirected from wages into the plan.

One important key to the successful implementation of a cafeteria plan is properly informing your staff of the plan’s positive and negative aspects. You are asking your employees to transfer some amount of future wages into your cafeteria plan. Naturally, such a plan allows a small business to offer benefits which would be otherwise unaffordable.

Code section 125 makes it possible for employers to offer their employees a choice between cash salary and a variety of nontaxable benefits (qualified benefits).

A qualified benefit is a benefit that does not defer compensation and which is excludable from an employee’s gross income under a specific provision of the Code, without being subject to the principles of constructive receipt. Qualified benefits include health care, vision and dental care, group-term life insurance, disability, adoption assistance and certain other benefits. See Sections 125(a), 125(f), 79, 105, 106, 129 and 137 of the Code. 

Employers may also offer flexible spending accounts to employees under a cafeteria plan that provides coverage under which specified, incurred expenses may be reimbursed. These include health flexible spending accounts for expenses not reimbursed under any other health plan and dependent care assistance programs. 

Employer contributions to the cafeteria plan are usually made pursuant to salary reduction agreements between the employer and the employee in which the employee agrees to contribute a portion of his or her salary on a pre-tax basis to pay for the qualified benefits. Salary reduction contributions are not actually or constructively received by the participant. Therefore, those contributions are not considered wages for federal income tax purposes. In addition, those sums generally are not subject to FICA and FUTA. See Sections 3121(a)(5)(G) and 3306(b)(5)(G) of the Code.

The above provides only the most basic rules governing a cafeteria plan. For a complete understanding of the rules, see the proposed and final regulations under Code section 125.

For more information, please call us at 1.800.508.1144.

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