Offering incentives without incurring high costs is an important part of acquiring and retaining qualified team members. It has been found that almost 70% of our workforce considers a company-sponsored healthcare plan a key factor in their working life. At the same time, most working people consider retirement options equally important.

For an employer, this means making important decisions about the benefits your company may offer to your team and choosing the best incentive for your employees as well as for your bottom line.

Section 125 Plans

One incentive is to offer an attractive healthcare package while, at the same time, saving money on health insurance premiums and increasing your team’s take-home income. This option is possible with a Section 125 or “Cafeteria” plan, which is an employer-sponsored benefit that allows employees to choose from a variety of pre-tax benefits. Thus, effectively reducing their taxable income.

Cafeteria plans offer some significant benefits both for your company and for your employees:

• Less taxes for employees: Employees will pay less in taxes because the money you put towards their Section 125 plans isn’t taxed as normal income.
• More money for out-of-pocket expenses: If you put $5,000 aside for an employee’s Section 125 plan, your employee enjoys a tax-free $5,000 they can use to cover out-of-pocket expenses. If you paid out this sum as part of their regular salaries instead, they would lose some of this money (often a double-digit percentage) to taxes.
• Less taxes for employers: Your company doesn’t have to pay FICA or FUTA taxes on employee wages set aside for Section 125 purposes. That means that you can reduce your annual business’s tax liability by thousands of dollars.

401k Plans

Another option is to offer a comprehensive 401k plan for your employees, which offers several benefits. These include:

• Tax advantages
• Employer contributions, and
• Retirement savings growth potential.

Contributions are typically made pre-tax, reducing taxable income and allowing for tax-deferred growth until withdrawal during retirement. There are a number of different 401k plans, each with their own requirements and benefits. 

According to the Internal Revenue Service, a 401k plan allows an employee to elect to have the employer contribute a portion of the employee’s wages to an individual account under the plan and offers the following benefits:

• Less taxes for employees: A 401k plan can be a profit-sharing, stock bonus, pre-ERISA money purchase pension, or a rural cooperative plan. Generally, deferred wages (elective deferrals) are not subject to federal income tax withholding at the time of deferral, and they are not reported as taxable income on the employee’s individual income tax return.
• Less taxes for employers: Employer contributions made on behalf of employees (including the business owner) are tax-deductible up to 25% of the eligible employee’s total compensation. This allows business owners to reduce their taxable income while building their own retirement savings and benefiting employees.

401k plans are typically meant for retirement – they don’t generally cover health care or insurance plans. Employees with a 401k plan can opt to withdraw some of their 401k for medical expenses, however, early withdrawals may be subject to a 10% penalty on top of regular income tax rates. Withdrawals for medical expenses must still comply with the 401k plan’s rules in order to potentially qualify for penalty-free exceptions.

Section 125 vs 401k

Comparing the benefits between a Section 125 plan and a 401k plan is a bit like comparing tennis shoes with basketballs—both are sports-related but have different purposes. Simply stated:

• The purpose of a Section 125 plan is to reserve part of their pre-tax cash earnings to cover the costs of qualified benefits such as medical and childcare expenses. Its primary goal is to significantly reduce healthcare costs and payroll taxes for both employer and employee. In other words, a Section 125 plan benefits your team while they are working in your company.
• The purpose of a 401k plan is to secure employee retirement benefits. Your employees will benefit by referring part of their pre-tax payments into the company’s 401k account, thereby reducing their income taxes. At the same time, employer contributions are deductible on the employer’s federal income tax return to the extent that the contributions do not exceed the limitations described in section 404 of the Internal Revenue Code. In short, a 401k plan benefits your team when they retire from the workforce.

Within both IRS sections, 125 and 401k, there are a number of different packages and options, each with its own benefits and obligations. Many companies carry both 401k and Section 125 plans. Both are not mutually exclusive.

What to Choose?

Unfortunately, there are no ready answers to that question. Both plans depend on the size of your company, your personnel structure, benefits already in place, and many other factors—not in the least the complexity of rules and regulations of the IRS.

Our team at Health Sphere can assist you in making these important decisions and providing options and strategies to make the right choice.

Find out what we can do for you today!