The advantage of a cafeteria plan is that employees have benefits plan options. For example, a young employee with no health problems might opt to spend cafeteria plan dollars on a minimal health plan. An employee with four family members might choose to spend the cafeteria plan dollars on a health plan with more comprehensive coverage. The employee without a family might choose to “spend” his or her benefits dollars for investments in a retirement plan.
No matter the goal of the employer’s cafeteria plan, the plans are, according to About.com’s Gregory Boop,
“named after Title 26, Section 125 of the United States Code where 'cafeteria plans' are specifically excluded from the calculation of gross income for federal income tax purposes.
"125 plans allow employees to contribute pretax dollars into the plan. Contributions toward plans are not subject to federal, state, or social security taxes. The contributions are placed into an account the employee can use to pay for allowed expenses (e.g., premiums for health insurance, dependent care costs, medical supplies). Since no federal, state or social security taxes are taken out and the dollars are not included as gross income, the employee saves anywhere from 27 - 50% on these purchases."
In a typical cafeteria plan, an employee might exceed the number of dollars allowed by the employer with the benefits plan choices made. In these cases, the employee pays a part of the premium for his or her chosen benefits, so the cost to employers is lower. For example, an employee with health problems or age 55 and above might choose to “buy up” to a more comprehensive health plan that covers more services.
In all cases, working to provide employees with a cafeteria plan for benefits deserves the assistance of a benefits plan professional who can advise the employer about options. Whether you are large enough to employee a compensation and benefits coordinator or rely on the assistance of trusted external advisors, I recommend getting advice.
The complexity of the tax code is such that you need professional assistance to devise a cafeteria plan that is legal and benefits both the employer and employees.
Disclaimer – Please Note:
Susan Heathfield makes every effort to offer accurate, common-sense, ethical Human Resources management, employer, and workplace advice both on this website, and linked to from this website, but she is not an attorney, and the content on the site, while authoritative, is not guaranteed for accuracy and legality, and is not to be construed as legal advice.
The site has a world-wide audience and employment laws and regulations vary from state to state and country to country, so the site cannot be definitive on all of them for your workplace. When in doubt, always seek legal counsel or assistance from State, Federal, or International governmental resources, to make certain your legal interpretation and decisions are correct. The information on this site is for guidance, ideas, and assistance only.