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The Cafeteria Plan (Section 125) is a type of salary deferral plan. With an employer-sponsored cafeteria plan, the employee can choose how to allocate pre-tax dollars among various qualified plans and investments. The most common form of this arrangement obligates the employer to contribute a certain percentage into each account for each pay period without regard to whether there are any funds left over in that particular account at the end of that time frame or not.
Cafeteria plans are a type of benefit that allows employees to choose from a variety of pre-selected benefits. They are typically offered by employers as an alternative to traditional health insurance, and they can be used in conjunction with any other type of coverage.
A section 125 cafeteria plan allows a company owner to provide low-cost employee perks while still saving money on payroll taxes. Employees can choose pretax benefits like medical or dental insurance or receive the equivalent amount on their paycheck, paying taxes on it. Section 125 is an IRS pretax vehicle nicknamed “cafeteria plan” because employees can choose pretax benefits like medical or dental insurance or receive the equivalent amount on their paycheck, paying taxes on it.
Check out ADP TotalSource if you’re searching for a simple solution to provide tax-free benefit packages to your workers. It’s a leading professional employer organization (PEO) that helps small companies handle payroll, recruit top talent, and retain employees with Fortune 500-level benefits in one simple platform. Request a free estimate.
Visit ADP TotalSource for more information. for more information.
What is a Section 125 Plan and How Does It Work?
A cafeteria plan is a pretax benefits plan that complies with the IRS’s section 125 standards. The fundamental advantage of a section 125 cafeteria plan is that workers get a set amount of money, regardless of whether they use it for pretax health-related benefits or receive it as part of their pay and use it for a taxable benefit like supplementary disability or life insurance.
Kristen Appleman, Vice President of Health & Wealth, ADP TotalSource
“A cafeteria plan may assist a small business by allowing it to be the kind of organization that gives perks and can attract talent.” However, many company owners conflate the term “benefits” with a cafeteria plan. While cafeteria programs are eligible for IRS section 125 pretax treatment, every cent matters in a small firm. Even if a company is too small to provide health insurance for its employees and their families, it may provide pretax choices such as health savings accounts [HSAs] or flexible spending accounts [FSAs] to its employees.”
Traditional Employer-Provided Insurance vs. Cafeteria Plan
In a standard employer-provided insurance plan, the company pays all or part of the premiums for its employees. If an employee decides they don’t need health insurance — for example, because they’re covered by a spouse’s plan — they’re out of luck and will not get the cash equivalent.
A section 125 cafeteria plan, on the other hand, allows your employee to get the allotted amount in cash or put it toward a benefit that isn’t included in the pretax plan, such as life insurance. Just keep in mind that if it’s used for pay or any other non-pretax benefit, the money will be taxed at the employee’s regular wage rate.
Section 125 Requirements of the IRS
The Section 125 Requirements of the IRS include that the business offers money to the employees that can be used to purchase health insurance benefits on a pretax basis. The employee can take the money and buy the insurance they need, or they can keep the money as part of their paycheck.
At least one taxable and one nontaxable offering must be included in a section 125 plan.
Benefits That Are Taxable
To be compliant with section 125 of the tax law, a cafeteria plan must contain at least one taxable benefit choice. The taxable option is considered part of the employee’s remuneration by the government. Allowing workers to accept the monthly amount as cash into their compensation instead of putting it toward the benefit plan is an example of a taxable choice. They might also use the money to pay for non-taxed services like a gym membership.
Pretax Benefits That Are Qualified
The plan must also contain at least one qualifying benefit, which is a benefit that is exempt from an employee’s gross income due to a particular provision of tax law, i.e., it is pretax.
The following are examples of qualified benefits:
- Health insurance and disability insurance are two types of accident and health benefits.
- Dental and vision insurance, for example, are examples of other medical insurance.
- FSA (Family and Dependent Care Assistance).
- HSA: A health savings account that is used to pay for medical expenses.
- A retirement savings plan, such as a 401(k) or an individual retirement account (IRA), is a kind of retirement savings account.
Compliance with the Cafeteria Plan
Your section 125 cafeteria plan must fulfill paperwork and communication standards to be compliant. To ensure your cafeteria plan is IRS section 125 compliant, we recommend engaging with a professional agency such as a PEO, insurance broker, or HR software.
1. A written plan
A section 125 plan document provides detailed specifics, such as a summary of the employee benefits covered by the plan and the costs associated with them. It also defines what constitutes a qualifying event, such as a spouse’s job loss or a transfer, as well as participation criteria, yearly limitations, and election processes. Each year, the employee is usually given a copy of the plan paperwork by the benefits provider.
2. A brief description of the plan
A summary plan description (SPD) describes the plan’s particular elements in clear language and includes your company’s eligibility and contribution regulations. It also specifies the plan year, claim filing methods, and sponsorship and administration details. An SPD should be issued at least once a year or anytime the plan choices change.
You must register the SPD with the US Department of Labor within 120 days of the plan’s effective date, in addition to disseminating it to your workers and their beneficiaries. See these IRS instructions for further information.
3. Ongoing Conformity
The laws are continually changing. Section 125 plans are not allowed to discriminate in terms of eligibility or benefits, which is particularly essential if you have a broad range of salary among your workers. The plan, for example, cannot be skewed toward your higher-earning employees. Employee communication regarding plan alternatives is also required, as is making paperwork accessible in the language your workers speak.
Appleman continued,
“It’s not simple to remember to send out essential alerts and reminders on time, but failing to do so might jeopardize your firm.” You’ll also need to make sure there’s no discrimination, that your filing with the different agencies is done right, that you’re in compliance with COBRA [Consolidated Omnibus Budget Reconciliation Act of 1985], and that you’re giving information in your team’s native language.”
This is why we advocate partnering with a certified benefits provider, whether it’s a payroll firm like Gusto, a professional employer organization (PEO) like ADP Total Source, or an insurance carrier. It’s crucial to comply with federal and state tax rules, as well as the Health Insurance Portability and Accountability Act (HIPAA), Affordable Care Act (ACA), and Employee Retirement Income Security Act of 1974 (ERISA) requirements that impact businesses of all sizes.
Plans for a Simple Cafeteria
You may be allowed to take advantage of a basic cafeteria plan, often known as a premium-only plan, depending on your state’s definition of small company (POP). That isn’t a self-funded plan like the ones given by major corporations that may set up and run their own health-care programs for their employees.
It’s a plan supplied in collaboration with a fully insured vendor, such as a health or dental insurance company. POP is a kind of tax-free vehicle available under IRS section 125 that has less regulatory requirements than a standard cafeteria plan for bigger employers.
Gusto’s Benefits Compliance Manager, Topher Reynoso
“A POP or basic cafeteria plan imposes much less restrictions on your company. You delegate insurance to a benefits provider and don’t handle claims yourself. There is less inspection and fewer notice and filing obligations. A POP is one of the numerous legal words that get thrown about when it comes to employer-provided pretax benefits. But they’re all covered under Section 125.”
Benefits on the Side
A cafeteria plan is a kind of supplementary benefit. Certain benefits, however, are eligible for pretax status under section 125 of the tax law. To help you understand material from the IRS paper on fringe benefits, here’s more on what fringe benefits are and how they function in layman’s words.
Section 125 Cafeteria Plans Typically Include Pretax Benefits
Here’s what you need to know about the three perks that a section 125 cafeteria plan typically includes. For your cafeteria plan, you may use simply one of them, a mix of them, or all three of them.
1. Deductions for pre-tax health insurance premiums
Most employer-sponsored health insurance plans, such as health maintenance organizations (HMOs), preferred provider organizations (PPOs), and point of service (POS) plans through health insurance carriers, allow employees to set aside a portion of their pretax salary to pay for their health insurance premium contribution through POP plans. A POP plan is the most basic sort of section 125 plan, and it’s straightforward to implement and manage.
HSAs are also included in this category and may function as a POP module. Because an HSA is linked to a high-deductible health plan (HDHP), it’s difficult to set up; as a result, several businesses avoid including an HSA in their cafeteria plan.
2. Account with a range of spending options
A flexible spending account (FSA) enables an employee to pay for some medical expenditures before taxes. FSAs are a kind of IRS-approved savings plan. Effectively, the employee uses money put aside in an account to pay for out-of-pocket expenditures that aren’t covered by insurance. If the FSA is the sole benefit offered, it may also be used to compensate workers for health insurance premiums paid. An FSA, on the other hand, may be used for dependent care.
3. FSA for Dependent Care Assistance
Employees who pay for child or adult care for their parents may use the dependent care assistance program (DCAP) FSA. Single workers may set aside up to $2,700 of their pretax earnings each year for DCAP, which includes costs they incur while working, looking for job, or attending full-time education. Care for a kid under the age of 13, daycare for parents, care for a handicapped family member, and summer day camps are all examples of qualified costs.
Don’t be alarmed if all of this seems daunting. Many payroll providers and professional employer organizations (PEOs) can assist you with the intricacies. The advantages of a section 125 plan for an employer are many, but hard to comprehend.
Common Misconceptions of Section 125 & Cafeteria Plans
Some small companies assume that the Affordable Care Act (ACA) has changed the way employers provide pretax health insurance benefits, but this is not the case. Instead, they increased the number of regulations. Furthermore, state-specific restrictions may apply to your cafeteria arrangements, depending on the size of your firm and where you conduct business.
ACA
Large companies with 50 or more workers or full-time equivalents (FTEs) are required under the ACA to submit a summary of benefits and coverage in addition to plan documentation and the SPD (SBC). That isn’t the same as the plan documents. It’s more in-depth and must be presented in your employees’ native language so that they can make informed health-care decisions. Employers with less than 50 employees are exempt from the ACA’s requirements.
COBRA
Furthermore, the right to continue receiving health insurance via an employer’s plan, known as COBRA, differs by state. COBRA is required in certain jurisdictions, including as California, for firms with less than 20 workers. So even if you’re not covered by the ACA, you may still be required to follow COBRA guidelines.
ERISA
The law that compels you to furnish an SPD to your workers is ERISA, not IRS section 125, and it’s not the same as the plan documents that the IRS needs for section 125 cafeteria programs.
Documentation of the Benefits Plan
Reynoso went on to say:
“Your firm is liable to IRS section 125 if you provide pretax health benefits to your workers. People believe that purchasing group health insurance would suffice, but this is not the case. You must send out notifications, establish a waiting time, and submit plan documents. The good news is that the IRS does not target small businesses.
“However, going out and purchasing insurance for your staff would be a mistake.” It’s far preferable to engage a broker or a third party to guarantee that your plan complies with all plan paperwork, employee notice, and employee rights obligations.”
Costs of a Cafeteria Plan
Cafeteria plans range in price from a few dollars per month to hundreds of dollars per year, depending on how much you, the employee, wish to contribute. The company and the workers both contribute money to set up and give benefits via your cafeteria plan. The company has the option of contributing money to each employee’s insurance premium.
The following are the key expenses and who is responsible for them:
- Plan setup & administration: The employer cost to set up a plan ranges from about $12 to $100 per month or more per employee; this cost is generally offset by the payroll Savings on taxes you will reap as an employer
- Employer contribution: This is a monetary allowance that you may choose to give to each employee’s benefits premium; the amount is determined by the insurance company’s minimum requirements. Some employers are required to pay up to 50%.
- Premiums for employees: This is the difference between what the insurance costs and what the company pays; it’s usually paid by the employee using pretax cash.
Premiums vary depending on the kind of plan provided, whether coverage is for a single employee or a family, and even where your workers live and work. Premiums for health insurance may run anywhere from a few hundred dollars per month to thousands of dollars per year. Read our Health Insurance Guide for additional information on the costs of various types of insurance.
Providers of Cafeteria Plans
PEOs, benefits insurance providers, and HRIS software capable of ensuring IRS tax compliance as well as adhering to federal and state requirements are the finest suppliers for a cafeteria plan.
Here are four companies that can assist you with establishing a section 125 cafeteria plan.
1. TotalSource ADP
As a way of offering employee benefits and insurance, ADP provides a PEO. They basically become a co-employer of your team, with payroll responsibilities as well. If you’re looking for a PEO, ADP TotalSource is a dependable option that allows you to provide Fortune 500-level benefits to workers and handle important HR responsibilities with fewer problems. Pricing is tailored to each employee and is likely to start at more than $100 per month. Request a free estimate.
Zenefits is number two.
Zenefits is a benefits insurance company that offers HRIS software as well as section 125-compliant health insurance, such as medical coverage, HSAs, and FSAs. If you want an all-in-one solution, it also provides HR assistance and can handle payroll. HR and benefits start at $9 per month per employee, plus a $40 service charge per month. Request a demonstration.
3. SimplyWorks
Justworks is a low-cost PEO service that offers entry-level pricing for small businesses who wish to start delivering employee benefits. Justworks’ PEO lets you pick and choose the services you want and pay for different levels of service. It’s not as comprehensive as ADP TotalSource, but it’s also less expensive, ranging from $39 to $99 per employee every month. Justworks is a great place to start.
4. Gusto
Gusto is a payroll service that also provides HR services such as employee onboarding. It also provides ACA-compliant health insurance in 24 states, but unlike some of the other carriers listed above, you may need to be more hands-on in ensuring your company satisfies all of the section 125 standards for companies in your industry, size, and region. Pricing for Gusto begins at $6 per month per employee, plus a $39 monthly service fee. Gusto is available for a free 30-day trial.
Pros & Cons of a Section 125 Cafeteria Plan
This section will concentrate on the advantages and cons of cafeteria programs for both you and your workers in order to make them more clear.
Advantages of a Cafeteria Strategy
First, consider the advantages of supplying a cafeteria plan to a small company owner:
- Employer Savings on taxes: The amount spent on benefits reduces payroll taxes.
- Employee Savings on taxes: Pretax revenues are used to buy perks for your workers.
- Reduced employee turnover: Offering perks makes it simpler to recruit and retain staff.
- Employees who participate and those who do not are treated equally, since those who do not get to retain the dollars you put to the cafeteria plan as income (taxable)
- Improves employee morale: Employees like having the option of choosing between perks and pay.
- You keep FSA monies that haven’t been spent: Unlike an HSA, where the employee may take their contributions with them, unused FSA funds are returned to your firm at the end of the year.
- COBRA exemption: Depending on the size of your company, you may not be compelled to maintain benefits if a key employee leaves.
Savings on taxes
Because your employees’ income taxes are reduced when you provide a cafeteria plan, your FICA, FUTA, SUTA, and workers’ compensation rates are all reduced. The cost of setting up the plan is offset since your payroll taxes have been decreased. If you feel comfortable managing the benefits packages yourself, you may take care of these taxes and compliance issues using payroll software.
The Drawbacks of a Cafeteria Plan
A cafeteria plan, like any other benefit plan, has its drawbacks. The following are the disadvantages of a cafeteria plan from the standpoint of both the company and the employee:
- It’s a difficult situation: Section 125 of the IRS tax law has 33 pages of instructions on how fringe benefits function, as well as an 11-page addendum outlining recent revisions to encourage same-sex marriage.
- Employees have one year to pick their plans and cannot alter their minds in the middle of the year if they opt to acquire health insurance.
- Use it or lose it: Some features, such as an FSA, are set up to be used or lost; for example, if an employee put up $1,000 for health care but only spent $250, the remainder reverts to the plan owner (you) at year’s end.
- Communication requirement: It is your responsibility to offer paperwork, communication, and education to workers about their alternatives, such as when they may sign up.
Because of the complexities of the laws, conflicting federal requirements, and state compliance difficulties, you should hire an insurance firm or a private insurance broker to assist you set up and convey your section 125 compliant benefits to your workers.
Here are a few instances of effective communication:
- Employees should be informed that if they do not utilize their FSA money for authorized costs during the year, they will lose them, which may be a burden for employers.
- Qualifying Events: Your employees must understand what constitutes a qualifying event, such as a marriage, a relocation, or the loss of a spouse’s employment, which may enable them to modify their benefits outside of the yearly enrollment period.
- Employees must be informed that they cannot take their benefits with them if they resign or are dismissed, and that their specified contributions are locked in for a year.
- Alerts: If you go paperless, for example, you’ll need workers to agree ahead of time to receive paperless notifications.
So, if Johnny and his wife run into financial difficulties and wish to cease contributing to the cafeteria plan, they won’t be able to do so until the year is out. If you don’t tell them right away, they may pursue legal action against you. If you create an exception to aid them, you are breaking section 125’s standards and may be placing your company at danger of discrimination, for example.
Appleman continued, “
“It’s not simple to remember to send out requirements and reminders on time; failing to do so might jeopardize your company.” You’ll also need to make sure there’s no discrimination, that your filing with the different agencies is done right, that you’re in compliance with COBRA, and that you’re delivering information in your team’s language.”
That’s why PEOs like ADP TotalSource are such a viable service choice for small business owners who want to provide their employees with big-company benefits. The PEO handles all regulatory issues, allowing you to focus on your business while your workers are happy. Call for a no-obligation quotation.
Alternatives to Putting a Cafeteria Plan in Place
If a cafeteria plan and all of its pretax requirements seem to be too complicated for you, examine alternative possibilities. Many of these might serve the same purpose of assisting you in attracting and retaining top talent.
Provide Bonuses & Incentives
When a cafeteria plan isn’t in the budget, some smaller firms utilize financial bonuses and incentives to attract and keep staff. For example, a company might provide employees cash bonuses if they meet sales targets, give incentives for each year they remain on the job, or make other adjustments to their pay to compensate for the lack of health coverage.
Offer Benefits on the Side & Perks
Other firms utilize innovative methods to keep their employees satisfied, such as employee benefits. Weekly pizza parties, ice cream socials, flex scheduling, and work-from-home choices are all possibilities. These may be less expensive than providing tax-free health benefits while still attracting and retaining staff. Some workers, in fact, prefer benefits over pay raises.
Think about profit sharing.
A provide sharing plan that provides employees a portion in the company is another method small business owners may encourage employees and recruit talent without setting up a cafeteria plan. Here’s how to put one together.
Set up a health insurance plan that is paid for by your employer.
Larger companies in the insurance or finance industries may be able to self-fund their medical coverage. This will always be subject to greater laws and scrutiny than a POP plan for a smaller firm. However, if you can afford it, a self-funded plan might save you money in the long term.
Frequently Asked Questions About Section 125 & Cafeteria Plans
Employee perks and tax incentives may be perplexing issues. Here are some of the most often asked questions by small company entrepreneurs.
What Is a Cafeteria Plan Document Under Section 125?
A section 125 pretax cafeteria plan normally comes with three types of paperwork. Document including the SBC, SPD, and Section 125 cafeteria plan. The cafeteria plan document is a long-form explanation of what’s available. Costs, coverage, and basic information are all included. In many circumstances, the plan document’s information may be extracted from the insurance vendor’s SBC document.
Where can I learn more about IRS Section 125?
The IRS’s section 125 is detailed in detail in a document called publication 15b, which may be found on the IRS website.
What Benefits Can’t You Get With a Section 125 Cafeteria Plan?
Any kind of reward is permitted. Not all perks, however, are accessible as pretax benefits. Unless section 125 explicitly exempts it and permits it to be delivered to workers pretax, all fringe benefits must be recorded as income to the employee. Employee discounts, relocating costs, retirement planning, commuter perks, education help, and tuition reimbursement are examples of non-pretax benefits.
Is it Taxable to Receive Fringe Benefits?
Any fringe benefit you offer to workers is subject to employment taxes and must be recorded on the employee’s W-2, according to the IRS. If you give fringe benefits to people who aren’t on your payroll, however, you may need to utilize an alternative tax reporting form, such as a 1099.
For the purposes of a cafeteria plan, who is considered an employee?
The definition of an employee goes beyond what you may expect and might change depending on the benefit provided. Depending on the benefits given in your plan, a full-time insurance agent, a leased employee who has worked for you for a year, or even the widow of an employee or a retiree may be considered “employees.”
Is it Possible for S-Corp Shareholders to Join a Cafeteria Plan?
Any shareholder who owns more than 2% of the shares in a cafeteria plan is not considered an employee. As a business partner, they may be allowed to partake in benefits, but they will not be able to buy those advantages before taxes.
What Is the Difference Between a Cafeteria Plan and a Qualified Small Employer Health Reimbursement Account?
Employer-sponsored health care may be given on a pretax basis via a cafeteria plan or a qualified small employer health reimbursement account (QSEHRA). A QSEHRA is a savings account that firms with 50 or less workers may use to buy health benefits for their employees, while a cafeteria plan may include health insurance as part of the plan. Employers with 50 or more workers are required to offer health insurance. An HRA is insufficient on its own.
What Mistakes Should You Avoid When Creating a Cafeteria Plan?
We spoke with our experts, Appleman and Reynoso, who both agreed that small firms make the following blunders when it comes to benefits in general and cafeteria programs in particular:
- Failure to communicate with and educate employees in a timely manner
- Notifications and filings are missing, incorrect, or late.
- Inconsistency in enforcing the rules and creating exceptions that jeopardize your strategy
Conclusion
A section 125 cafeteria plan may help a small company owner give perks while saving money on taxes and keeping their workers satisfied. However, to accomplish this right and gain the advantages while remaining compliant, we suggest working with a professional provider.
Whether you opt to set up a cafeteria plan or not, don’t forget to look at ADP TotalSource, a PEO that can help you recruit top personnel, handle payroll and compliance concerns, and provide valuable benefits to your workers. Request a free estimate.
Visit ADP TotalSource for more information. for more information.
Section 125 is a cafeteria plan that allows employees to choose the benefits they want. There are many features, costs and providers available under this type of plan. Reference: what benefits are included in section 125.
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