Cafeteria Plan: Definition and Typical Options for Employees

Detailed rules cover the types of changes in status relating to employment, marital status, dependents, etc., that may be permitted in the plan documents. Cafeteria plans are a vehicle for employers to offer certain benefits to employees on a tax-free basis. cafeteria plans are also referred to as Section 125 plans, after the section of the Internal Revenue Code (IRC) that regulates such arrangements.

A Health Savings Account is a tax-advantaged savings account that employees can use to save for qualified medical expenses. Offering HSAs can help attract and retain employees by providing a valuable benefit and potentially reducing their tax burden. Second, a cafeteria plan can help employers attract and retain top talent. By offering a comprehensive benefits package, employers can show their employees that they value their health and wellbeing. This can lead to increased job satisfaction, higher morale, and lower turnover rates. Under Section 125 of the Internal Revenue Code, cafeteria plan sponsors must offer employees a choice between at least one taxable benefit (such as cash) and one pre-tax benefit (such as disability insurance).

  1. A POP plan lets an employer set aside part of worker’s pretax earnings specifically to pay for health insurance premiums.
  2. Employers can save an additional 7.65% on their share of payroll taxes.
  3. The rules for a flexible spending account (FSA) differ slightly from the “use it or lose it” rules that apply to other cafeteria plan benefits.
  4. Cafeteria plans are particularly good for participants who have regular expenses that are related to medical issues and child care.
  5. This type of customized menu provides employees with more take-home pay and several additional benefits.

Employers must maintain constant communication with each employee about changes in the cost of benefits, their coverage, and their use of benefits. Yes, non-qualified HSA withdrawals may be subject to income tax and an additional 20% penalty, up until age 65. After age 65, withdrawals for anything other than qualified medical expenses remain subject to ordinary income tax, similar to a traditional IRA. Health Savings Accounts can be a very useful tool for supplementing retirement income.

Benefit Tips

HSA funds used for non-medical expenses are subject to income tax and an additional 20% penalty. However, after age 65, HSA funds can be withdrawn for any purpose without the additional penalty (though income tax may still apply). Yes, small businesses can offer HSAs as part of their employee benefits package, regardless of their size. However, there may be certain eligibility requirements and contribution limits to consider. So they can be labor-intensive to maintain and manage, costing companies money. Not only can employees better control their tax liability with a Section 125 plan, but employers also defray some of their costs.

What Is an Example of a Cafeteria Plan?

If a premium-only plan satisfies the eligibility test for a particular plan year, the plan is treated as meeting the nondiscrimination rules of Section 125 for that plan year. It involves a credit system that the employee can use on a discretionary basis for qualified expenses. Employees can then supplement the CDHC with their own money and use it to buy additional benefits or coverage. Determining how much money you want to set aside for the year can be a challenge—one you’ll want to discuss with your benefits administrator.

Another benefit that some employees can take advantage of under Section 125 is the health savings account (HSA). Only employees who choose to use a high-deductible health plan (HDHP) are eligible for an HSA (an HDHP must have an annual deductible of $1,400 individual/$2,800 family). HSA contributions in 2022 are limited to $3,650 for individuals and $7,300 for families. Before this notice, reimbursements were permitted only for claims incurred during the plan year.

Are there contribution limits for HSAs under a Section 125 plan?

The plan documents must be furnished to all plan participants every 10 years, if the plan has not been updated, or every five years, if the plan has been updated. A section 125 (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. The contributions you make as an employee into a Section 125 plan are made “pre-tax,” meaning the money deposited into your account is taken out of your paycheck before you pay taxes.

Individuals are encouraged to seek advice from their own tax or legal counsel. There’s no cost to you for participating, and you can reduce the tax bite taken out of your paycheck. The following is a list of over-the-counter items the IRS has determined to be primarily for medical care and eligible for reimbursement. Over-the-counter medicines are allowable only with a written recommendation from a physician.

For example, $25 per pay period is automatically deducted tax-free if an employee elects to have $600 per year deducted from their pay and placed into the plan and the company has 24 pay periods. The money is sent to the plan’s third party administrator to be held. It can then be distributed for reimbursement upon request for qualified expenses. Allows for pre tax (salary reduction) and reimbursement of qualified parking and Transportation expenses. If you are self-employed, you are not considered an employee and are not eligible for a cafeteria plan, whether it is set up by you or another person. Employees must estimate how much money they are going to contribute to their cafeteria plan before the tax year begins.

Eligibility for Section 125 plans

When an employee elects to participate in a cafeteria plan, you as the employer will provide them an amount of money each year that they can use to pay for their chosen benefits via a cafeteria plan. Employees can customize a cafeteria plan to meet their unique needs thanks to flexible plan options. An employee with a big family may be better suited to a health plan with extensive coverage. Whereas the greatest option for a retiring employee may be the ability to contribute to his or her 401(k) plan.

It’s called a “cafeteria plan” because, like the dining options at a cafeteria, employees can pick and choose the healthcare options they want, such as medical, dental, vision, and other benefits, while declining ones they don’t. Cafeteria plan selections include insurance options, such as health savings accounts (HSAs), group term life insurance, and disability insurance. Other popular selections include adoption assistance plans, flexible spending accounts, and cash benefits. A cafeteria plan allows employees to choose between receiving taxable cash compensation or certain qualified benefits that are excluded from their  taxable income. Instead of receiving this compensation in the form of taxable cash income, employees can choose from a menu of benefits.

For plans like FSAs, if you don’t use all the money, you’ll lose it, so a cafeteria plan may be a good choice for you if you know you have qualified expenses, and how much they usually cost each year. Employees estimate how much they want to contribute to the cafeteria plan before the beginning of the tax year. This amount is divided by the number of payroll periods and subtracted from each paycheck.

And when it comes to learning more about cafeteria plan HSA – you’re in for a lot of abbreviations! This program was named after the most initial types of policies that enabled employees to pick between different sorts of benefits. The analogy was quite clear – the plans worked in the same manner as a customer that decides between available meals and beverages in a cafeteria. If you are covered by a cafeteria plan, you can only choose which benefits you will use once per year. There are exceptions, but generally you have to wait until the next plan year to change. Division EE of the Consolidated Appropriations Act of 2021 offers more discretion for FSA and dependent care assistance programs.

Disproportionate numbers of lower-paid participants chose cash over benefits, leading to uninsured or underinsured employees. 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. Regarding the taxable benefit option, for employees who opt into a Section 125 Cafeteria Plan, the employer may offer the cost of their traditional group healthcare plan premium as a cash addition to employees’ salaries.

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