Cafeteria plans, also known as Section 125 plans, allow employees to customize their benefit plans. Employees decide which of the employer-offered benefits they need and choose whether to take the benefit or receive cash instead. If the employee chooses cash, such payments are taxable. However, if the employee opts to participate in a Section 125 plan, his qualified contributions are typically tax-exempt for both the employee and the employer.
Types of Benefits Included
Only certain types of benefits can be included in a cafeteria plan. The employee may choose to pay for health or accident insurance with pre-tax dollars, contribute to his 401(k) plan or fund his health savings account if it is not an Archer account. He may choose to fund, with pre-tax dollars, his account for dependent care. Certain group life insurance is eligible for inclusion as well, and adoption assistance is a permissible benefit.
Benefits Specifically Excluded
Cafeteria plans, under the IRS code, cannot include reimbursement for moving expenses, commuting or transportation benefits, meals, or educational benefits. Memberships or fees for an athletic facility, such as a gym or golf club, are not allowed. Archer MSAs are excluded. Benefits the employer provides, such as lodging on the business’s premises, cell phones and discounts, cannot be included in a cafeteria plan.
The IRS does not permit doubling up on benefits; if an employee chooses to use pre-tax dollars to pay for his cafeteria plan donations, he cannot claim the same expenses as deductions when filing his return. This is because the portion of his wages used to make these payments has already been excluded from his taxable income. Neither the employee nor the employer pays Social Security or Medicare taxes on the exempted wages. The employer does not pay federal unemployment tax on the exempted portion of the employee’s wages. Because an employee’s contributions to a cafeteria plan are excluded from his Social Security wages, this has the potential to reduce his future benefits from Social Security or other retirement plans.
Disadvantages of Cafeteria Plans
Employees are typically locked in to the plan for a full 12 months, although certain events, such as a change in marital status or loss of spouse’s medical coverage, may permit mid-year changes. Flexible spending accounts such as dependent care are subject to forfeiture if the employee does not spend all of the money deducted.
Jeffrey Joyner has had numerous articles published on the Internet covering a wide range of topics. He studied electrical engineering after a tour of duty in the military, then became a freelance computer programmer for several years before settling on a career as a writer.