One of the best ways to acquire and retain talent is to offer a great benefits package for employees. According to an employee benefits study, more than 80% of job seekers give some or heavy consideration to certain benefits.
For employees, benefits are essential to quality healthcare, comfortable retirement savings, and much more. On the other hand, with soaring employer health insurance costs, saving money for business owners can be difficult. One option to cut costs and payroll taxes that is often overlooked is a Section 125 plan (also known as a “cafeteria plan”).
What is a Section 125 Plan?
Section 125 or Cafeteria plans are a means for employers to offer certain benefits to employees on a tax-free basis. These plans are named after the section of the Internal Revenue Code (IRC) that regulates such arrangements.
Section 125 plans are tax-advantaged. Because they are funded using pre-tax deductions, an employee’s taxable income decreases by the amount they use toward cafeteria plan contributions.
This means the employee will pay less federal income tax, as well as lower Medicare, and Social Security taxes. Depending on their location, employees participating in these plans can save between 28% and 48% in total federal, state, and local taxes on the portion of their income that goes toward cafeteria plan contributions.
Employers equally benefit from offering a Section 125 plan, by receiving a reduction in the amount of income used to determine payroll taxes. This includes reduced tax liabilities for Medicare, Social Security, and federal unemployment (FUTA). There can also be additional savings on withholding taxes in some states.
Benefits and Savings Examples
The tax savings for employees under the cafeteria plan can be substantial. For example, an employee who spends $200 a month in pretax dollars for benefits can in effect save $60, assuming about 30 percent of the $200 would have gone to federal, state, and local income taxes and Federal Insurance Contributions Act (FICA) taxes—the ones deducted for Social Security and Medicare.
The employer also saves on taxes. For example, for each $200 a month that an employee sets aside, the employer saves about $15, which is the 7.65 percent of the employee’s wages that the employer would otherwise pay in FICA taxes.
Section 125 Plans Deductions
Another great advantage of cafeteria plans is that they offer deductions your employees can use to contribute pre-tax gross earnings towards various benefits. Such deductions lower their taxable income, thereby significantly reducing their taxes. Because contributions are made before taxes, employees are not required to pay federal income tax on these amounts.
For employers, these deductions reduce payroll taxes. For example, employers can save $60,000–$70,000 per 100 employees per year on payroll taxes, reducing overall business expenses. Additionally, since employee contributions are made before taxes, employers do not have to pay FICA or federal unemployment taxes on contribution amounts.
Another advantage is that employees receive an effective raise without any additional cost to the employer. More participation in the plan equates to more tax savings for the employer, so the employer is often encouraged to promote increased participation by employees who are not yet in the Section 125 plan.
Eligibility
Any company with employees who are subject to U.S. income taxes is eligible to sponsor a cafeteria plan. Such companies can be C corporations, S corporations, LLCs, partnerships, governmental entities, or sole proprietorships. Section 125 plans may also include former employees, depending on the plan structure. However, the plan is not primarily meant for former employees.
There are a few non-discriminatory requirements that must be met before implementing a cafeteria plan in your company:
- Eligibility: Your plan cannot only benefit your company’s highest-paid key employees to participate.
- Benefits and contributions: The benefits and contributions you offer must favor employees of all compensation equally.
- Concentration: The value of the benefits for your key employees must be at most 25% of the value of all your employees’ benefits.
Review Your Options with Health Sphere Today
We invite you to explore the savings and advantages of a Section 125 Plan, and Health Sphere is ready to assist you. Our PCMP program simplifies the process, ensuring compliance and ease. Find out how much your business can save today!
