Pre-Tax Flexible Benefits – The Pros and Cons of Cafeteria Plans

A cafeteria plan, also known as a Section 125 plan, is a way for employers to provide multiple benefits while lowering taxes for themselves and their employees.

While more choice is always welcome, there are some drawbacks to cafeteria plans. Here’s what you should know if you’re considering offering this benefit. Background A cafeteria plan sometimes is referred to as a flexible benefits plan because it allows employees to choose from a variety of qualified benefits, which are generally not included in gross income.

Employees decide how much of their gross income they want to use for benefits before any taxes are calculated and deducted. Qualified benefits include:

• Accident and health benefits
• Adoption assistance
• Dependent care assistance
• Group-term life insurance coverage not exceeding $50,000
• Health savings accounts including distributions to pay for long-term care services

Employer‐provided benefits that are not included in gross income and are not allowed in a cafeteria plan are called nonqualified benefits. Nonqualified benefits include:
• Scholarships
• Employer-provided meals and lodging
• Educational assistance
• Fringe benefits.
There are several types of cafeteria plans:
Full flex plans: Employers make contributions for all plan-eligible employees, which they can use to buy various benefits. For benefits that employer contributions don’t cover, employees can make pre-tax contributions.
Premium-only plans (POPs): Employees can choose between receiving their full salary in cash or use a share of it to pay group insurance policy premiums on a pretax basis.

Simple cafeteria plans: In exchange for contributing to each eligible employee’s benefits, employers with 100 or fewer employees can get safe harbor from certain plan nondiscrimination requirements.

Flexible spending arrangements (FSAs): These allow employees to make contributions toward health care and dependent care expenses on a pretax basis.