More and more employers are using different types of employee benefits plans allowed by the Internal Revenue Service (IRS). Benefits are also important for businesses as they significantly enhance job satisfaction and overall employee experience, making it essential for HR managers to stay informed about the various options available.
One of these options, the Section 125 or “Cafeteria” plan, has been in existence since 1978 and offers some great advantages. It is also the easiest plan for your company to create pre-tax benefits without having any costs.
A Section 125 Plan, Explained
A Section 125 plan enables your employees to take taxable benefits, such as a cash salary, and convert them into nontaxable benefits. These benefits can be deducted from an employee’s paycheck before taxes are paid.
Employees who are enrolled in a Section 125 plan can set aside insurance premiums and other health care options from their pretax wages, which includes qualified medical and childcare expenses. Depending on where they live, employees can save from 20% to 40% in combined federal, state, and local taxes on a variety of items that they normally would purchase without out-of-pocket post-tax funds. At the same time, employers can save an additional 7.65% on their share of payroll taxes.
Types of Section 125 Plans
The IRS Section 125 plans come in several formats, designed to meet different needs and organizational structures. The most common types of Section 125 plans are the following.
1. Premium-only plan (POP)
This is the most common plan, as described above. In combination with group health insurance, a POP reduces taxable income and results in a reduction in the amount used to determine your company’s FICA and FUTA payroll taxes, as well as any applicable state taxes.
Among the Section 125 plans, a POP plan is a great option for employers looking to simplify their benefits offerings. However, it’s important to note that a POP may only be offered by an employer with a group medical plan.
2. Flexible spending accounts (FSA)
Offered solely in conjunction with a group medical plan, an FSA benefit will allow your employees to budget for predictable out-of-pocket medical expenses, such as co-pays, routine prescriptions, or dental care. These plans have an annual contribution limit and unused funds are usually forfeited at year-end. FSA rules allow pre-tax deductions to be used to fund these applicable medical expenses and can lead to significant amounts saved each quarter and year.
3. Full flex plans
Full flex plans allow eligible employees to purchase benefits using company contributions. Benefits not fully covered by the employer can be paid by the employee via pretax payroll deductions. Full flex plans offer employees a wide range of options since they can choose from various benefits and pay for them using pre-tax dollars, maximizing their tax savings.
4. Simple cafeteria plans
Simple cafeteria plans are designed for employers with 100 or fewer employees. These plans offer equal benefit contributions to all eligible employees. This makes them particularly appealing to smaller businesses looking to simplify their benefits administration while ensuring compliance with IRS regulations.
At Health Sphere, we can service any company size, from 20 employees and up.
Setting Up Your Section 125 Plan
To set up a Section 125 benefits plan, there are some requirements that need to be fulfilled per IRS instructions.
- Employers will have to draft a document that outlines the benefits offered, contribution limits, participation rules, and other information required by the IRS.
- Employers may also have to perform non-discrimination tests, depending on the plan, to ensure that it doesn’t favor highly compensated or key employees.
- After plan approval, your payroll calculations will have to be adjusted to allow for the plan’s pretax benefits.
- Your team will have to be briefed on the plan, their options and what benefits they can expect.
- The execution of your Section 125 plan will have to be monitored and supervised to stay in compliance with IRS regulations.
Making it Easy
Without the proper knowledge, setting up your Section 125 plan, dealing with the paperwork, adjusting your payroll, and monitoring compliance can be daunting, to say the least.
At Health Sphere, we specialize in tailored Section 125 solutions designed to help you reduce tax liabilities while providing your employees with meaningful benefits. With over a decade of experience in tax compliance and employee benefits, we simplify the process to make it cost-effective and fully aligned with regulatory standards.
Our innovative programs will empower you to offer tax-efficient benefits without upfront costs, thereby boosting employee satisfaction and retention. Find out how we can help you today!
Sources:
Internal Revenue Service, Introduction to Cafeteria Plans
Internal Revenue Service, Section 125 – Cafeteria Plans
