Section 125: Employee Benefits Cafeteria Plan

5 minute read

What Is a Section 125 Plan?

Section 125 of the Internal Revenue Code is also known as an “Employee Benefits Cafeteria Plan.” These plans cover a wide range of employee benefits, providing flexible and tax-free spending and savings options for workers.

A Section 125 plan (also known as a cafeteria plan) is a type of employee benefits program that allows employees to choose between their pre-tax earnings or employer contributions. The contributions may be allocated towards different types of benefits such as medical expenses, health insurance premiums, dependent care expenses, retirement savings accounts, life insurance policies and more.

Employees can also receive employer matchings if they opt to contribute to their retirement plan. Depending on what type of account(s) your employer makes available through the cafeteria plan, employees can save on federal and state taxes on their contributions or earnings up to certain limits each year.

Types of Benefits Offered Through a Section 125 Plan

The benefits offered through the plan will depend on your employer’s participant agreement but generally include:

Health Insurance – Many employers offer health insurance from carriers like Blue Cross/Blue Shield or United Healthcare with varying levels of coverage at different price points so employees can make an informed decision about which option best meets their needs without breaking the bank.

Dependent Care Assistance – This benefit helps cover costs related to daycare for children or adult dependents that you provide care for who live with you at least eight hours per week on average. Funds are deposited directly into your flexible spending accounts (FSA).

• Life Insurance – Employer-provided life insurance premiums are typically eligible for section 125 deductions while many voluntary policies offered through payroll deduction may qualify as well depending on the insurer’s guidelines.

Advantages & Disadvantages of a Section 125 Plan

Advantages

Low Cost – Many employers offer basic section 125 plans without any cost since there’s no fee associated with setting up the plan itself.

Flexibility – Employees have complete control over how much money they wish to put away in order to receive tax deferred growth.

Increased Savings – Since contributions are taken out before federal income taxes are applied, employees have an opportunity to save more money over time.

Secure Investment – Funds put away in these accounts stay safe until used by date specified by employee contracts.

Disadvantages

Character Limitations – Some types of expense accounts included within section 125 plans have strict eligibility requirements which means some employees may not be able to take advantage of them.

Limited Options – Not all employers offer all possible benefits programs which could leave some people stuck with suboptimal choices.

How Do You Set up a Section 125 Benefits Plan?

Employers must create an official plan document that outlines the specifics of the plan, including eligibility requirements, benefit limits, and other rules. After the document is completed, employers must register the plan with their state's department of labor or insurance commission. Finally, employers should communicate the details of the plan to employees so they are aware of their rights and responsibilities under the plan.

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What Is a Health Benefit Alternative to Section 125 Plans?

For employers looking for health benefit alternatives to Section 125 plans, premium-only HRAs, premium-plus HRAs and integrated HRAs are all viable options.

Premium-only HRAs

Premium-only HRAs allow employees to set aside pre-tax money to cover the cost of their insurance premiums.

Premium-plus HRAs

Premium-plus HRAs go a step further by allowing employees to also set aside pre-tax money for medical expenses not covered by insurance.

Integrated HRAs

Integrated HRAs combine traditional medical coverage with an employer contribution towards employee medical expenses.

Conclusion

Section 125 cafeteria plans are an important tool for employers looking to provide their employees with financial benefits and incentives. By setting up a Section 125 Plan and communicating the details of the plan to employees, employers can help ensure their employees are able to save money while still receiving the financial resources they need.

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