August 12, 2021

Have you heard of Cafeteria plans yet?
Cafeteria Plans
are also known as Section 125 Plans as they are based on Section 125 Internal Revenue Code. A Cafeteria plan refers to a type of employee benefit plan where an employer offers employees combination of both taxable and non-taxable benefits as part of the employee’s compensation. Currently they are offered specifically in United States. Cafeteria plans enable employees to receive and pay for benefits on a pretax basis. It means, the benefit amount is withheld from the employee’s compensation before taxes thereby reducing the employee’s taxable wages and increasing their net pay. Cafeteria Plans have recently become really popular. Employees appreciate the plan because they can purchase benefits with pre-tax dollars, which results in an increase in their take-home pay.  Employers like Cafeteria Plans because they also save on taxes.  This type of compensation helps employers attract the best employees.

Cafeteria Plan Benefits

The above diagram illustrates example of the benefits that an Employer can include in a Cafeteria Plan. However, examples of a few benefits that are exempted from Cafeteria Plans are:
  • Federal Income Tax,
  • Social Security Tax,
  • Medicare Tax,
  • Federal Unemployment (FUTA) Tax, and
  • State Income tax.
Education assistance is not a part of cafeteria plan. For full scope of approved and exempted benefits please consult with you Human Resource or Benefits Administrator. Also, a key requirement of traditional cafeteria plans is that they must undergo annual non discrimination testing.

Eligibility of Cafeteria Plan

A simple cafeteria plan is one that enables Employers with 100 or fewer Employees to bypass annual non-discrimination testing, if the following requirements are met:
  • Employer size – You must have 100 or fewer employees during either of the 2 previous years. Once the Simple cafeteria plan is established, company will remain eligible until it employs 200 or more employees. At the 200-employee mark, the company is no longer eligible for this plan.
  • Employee eligibility and participation – Generally, all employees with at least 1,000 hours of service during the preceding plan year must be allowed to participate in the Simple cafeteria plan. Certain employees are excluded from this requirement, such as employees under the age of 21 or those with less than 1 year of service. All eligible employees can avail any benefits provided under this plan. If there is any limitation, it must apply to all employees.
  • Employer contributions – The employer must make contributions toward the benefits of each eligible employee who is not an HCE (Highly Compensated Employee) or key employee. Employer contribution must be at least 2% of the employee’s compensation for the plan year, or 6% of the employee’s compensation for the plan year or twice the employee’s salary reductions — whichever is smaller. Separate rules apply to employer contributions for HCEs and key employees. Please refer to your Benefits Administrator for specific information that applies to your company or yourself.

Cafeteria Plan Types

Primarily there are three (3) types of Cafeteria Plans:
  • Premium Only Plan (POP) The most popular type is Premium Only Plan. This type of Cafeteria Plan allows employees to pay their health insurance premium with tax free money resulting in lower employee taxes. This is a popular cafeteria plan option.
  • Flex Account Flex Account or Flexible Spending Account (FSA) is the next type of Cafeteria Plan. This type of cafeteria plan gives employees the option to enroll in an account that allows them to set aside money from their paycheck tax-free and use it for qualified medical expenses. The amount is specified by the companies and shared with their employees based on their Benefits Provider and may vary from Provider to Provider.
  • Dependent Care Assistance Plan (DCAP) A Dependent Care Assistance Plan (DCAP) is an employee benefit plan that helps employees pay for the care of a qualifying dependent. The different types of care assistance included in this are day care, nursery school, preschool, before/after-school care, adult day care facilities, and adult in-home day care.Persons qualified for care under a DCAP include:
    • A dependent that is under the age of 13 when the care was provided and can be claimed as an exemption on a participant’s income taxes.
    • A dependent who is mentally or physically challenged and can be claimed as an exemption on a participant’s income taxes.
    • A spouse who is mentally or physically challenged.

Cafeteria Plan Pros and Cons

  • Employers and Employees Pay Less Tax Employers do not pay FICA or FUTA taxes on salary reductions amount. Employees do not pay federal income tax, FICA tax, and, in Michigan and most other states, state and local income taxes on their salary reduction amounts.
  • Addresses Employee Specific Needs Employees can choose benefits that meet their individual needs and adjust those choices annually as needs change. These allow Employers to provide for Employees personalized benefits tailored to their special needs.
  • Cost Control Cafeteria plans help Employer’s control costs by ensuring that money is not spent on benefits that Employees do not want or need.
  • Competitive Benefit Program By offering more flexible cafeteria-type benefits, Employers gain an edge in attracting and retaining valuable Employees.
  • Improve Employee-Employer Relationship Giving Employees flexibility and control over their benefits promotes goodwill and creates a partnership in the benefit program between employer and employee.
  • Respond to Work-Force Diversity Cafeteria plans can provide variation of benefits that can meet benefit needs of diverse employees.
  • Better Understanding of Benefits A better understanding of the benefits package results when employees are actively involved in the selection process.
While cafeteria plans are advantageous to both employers and employees, Employers also need to consider the drawbacks with these types of plans. The uniform reimbursement rule can put the Employer at risk if an Employee in a health FSA quits before contributing the full amount for which she has been reimbursed. On the other hand, if Employers institute the “use it or lose it” rule, an Employee could end up forfeiting unused FSA contributions. However, with proper planning and good communication, the effect of any disadvantages can be greatly minimized.

Please use this blog for informational purposes only. Work with your Benefits Provider to understand their specific offerings if you are an Employer and with your company if you are an employee.

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About Author:
Nayan Meher is a Senior Technical Consultant at Smart Tech Inc. with 15+ years of experience in Information Technology. He is a technical person with an Incentive Compensation Management specialization.

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