|
Section 125
Setting up and implementing a pre-tax Section 125 Cafeteria Plan:
An employer needs to establish what type of plan that will provide the
solution to their unique plan needs, set up the plan with proper
documentation, notify & educate employees, and perform
non-discrimination testing.
BASIC - Premium Only Plan (POP):
Allows for employees to pay their portion of the group insurance
premium on a pre-tax basis and is a good start to saving taxes for you
and your employees.
MIDDLE - Flexible Spending Accounts (FSA):
Generally, there are two FSA accounts including a Medical FSA (medical
/ dental / vision) and a Dependent Daycare FSA. These FSA
accounts will allow for the unreimbursed out-of-pocket expenses to be
paid on a pre-tax basis. Examples include dependent daycare,
office co-pays, prescription co-pays, eye exams, eyeglasses, contacts,
orthodontics, etc…
FULL - Cafeteria Plan / Consumer Driven Health Care (CDHC) plan:
Utilizing "credits or benefit bucks" allows the employer to
provide employees with a limited number of employer sponsored credits,
which the employee then decides where they'd like to apply these
credits within the menu of benefit options within the company's benefit
program. Employees may then supplement with their own dollars to
buy additional benefits or increase levels of coverage.
What is a Section 125 cafeteria plan?
What is a full cafeteria plan?
What is a Premium Only Plan (POP) (Premium Conversion)?
What is a Flexible Spending Account (FSA)?
What are the employee benefits of cafeteria plans?
What are the employer benefits of a cafeteria plan?
Who can participate in a Section 125 Premium Only Plan?
What are the setup costs?
What are the requirements of a cafeteria plan?
What must an employer do to offer a cafeteria plan?
What is a Section 125 cafeteria plan?
A Section 125 cafeteria plan allows an employer to set up two or more
benefit plans, giving employees the opportunity to save money in
reduced taxes. This is accomplished through payment of certain
qualified expenses with pre-tax dollars by redirecting a portion of
their salary into the plan.
What is a full cafeteria plan?
A full cafeteria plan usually includes Premium Only (POP) (Premium
Conversion) and Flexible Spending Account (FSA) features. Under this
plan, employees receive a lump sum of money to spend on their benefits
and the employer provides a menu of benefit options for employees to
choose from. If the employee does not use all of their allotted money
towards benefit costs, whatever is leftover will be included in the
employee's taxable income for the year.
Full cafeteria plans are popular in very large companies. Due to the
high level of flexibility offered to the employees, the maintenance on
this type of plan can be extreme.
What is a Premium Only Plan (POP) (Premium Conversion)?
This plan allows employees to make their contributions to group health
and group term life insurance with pre-tax dollars. A Premium Only Plan
creates no new benefits. The employer is simply offering a way to
obtain favorable tax treatment on benefits already offered. Here's how
it works:
-
Employees' premium contributions are automatically deducted from their salaries before taxes are taken out.
-
Taxable income is reduced by the amount contributed, so employees pay less in taxes and have more take-home pay.
-
With employee pre-tax income lowered, employers pay less in Social
Security (FICA) payroll taxes. (A business should consult their tax
advisor for applicable state legislation.)
A POP is the simplest type of Section 125 plan, and it requires low maintenance once it has been set up.
What is a Flexible Spending Account (FSA)?
This plan allows employees to use pre-tax dollars to pay dependent care
expenses and medical bills not covered by their insurance. Usually
offered in conjunction with a POP, the FSA is a budgeting tool that can
help take care of out-of-pocket expenses such as day care, dental and
optical care deductibles, co-pays, and prescription drugs. Like a POP,
an FSA helps pay for itself by increasing employee take-home pay while
decreasing employer payroll taxes. Here's how it works:
-
An employee decides how much of their salary should be set aside before taxes are calculated.
-
This amount is automatically deducted from their paycheck every pay
period, just like any other payroll deduction, and is deposited into
their FSA account.
-
The employees would pay their out-of-pocket expenses up-front, then
submit a claim and documentation and a reimbursement is made from their
own account.
Out-of-pocket expenses include:
-
Eyeglasses and contact lenses
-
Medical insurance deductibles
-
Prescriptions
-
Co-payments
-
Orthodontia
-
Chiropractic services
-
Dental treatments
-
X-ray and laboratory services
Dependent care expenses include:
-
Care for a child under the age of 13
-
Care for a disabled spouse or dependent incapable of caring for him/herself
-
Household-related services (i.e., visiting nurse)
The flexibility of an FSA plan makes it the best option for small to medium-sized companies.
What are the employee benefits of cafeteria plans?
-
Allows employees to withhold a portion of their salary on a pre-tax basis to cover the cost of:
-
Qualifying insurance premiums
-
Medical expenses
-
Dependent care expenses
-
Reduce gross income for tax purposes
-
Increases take-home pay
Example of employee savings
| EMPLOYEE |
WITHOUT Section 125
|
WITH Section 125 |
| Employee gross pay |
$1000 |
$1000 |
| Medical premium |
$0 |
$100 |
| Taxable income |
$1000 |
$900 |
| Tax rate |
25% |
25% |
| Taxes withheld |
$250 |
$225 |
| Employee net pay |
$750 |
$675 |
| Medical premium |
$100 |
$0 |
| Take home pay |
$650 |
$675 |
The person with the Section 125 plan paid less in taxes and took home more pay.
What are the employer benefits of a cafeteria plan?
The employer benefits by a reduction in their payroll tax liability by eliminating matching FICA taxes of 7.65%.
Example of employer savings
| EMPLOYER |
| Pre-tax Section 125 contributions |
$1000 |
| Number of employees |
x20 |
| Total employee contributions |
$20000 |
| FICA factor |
x .0765 |
| Estimated annual FICA savings |
$1530 |
Who can participate in a Section 125 Premium Only Plan?
Employees of:
-
Regular corporations
-
S corporations
-
Limited liability companies (LLC’s)
-
Partnerships
-
Sole proprietors
-
Professional corporations
-
Not-for-profits
The Code prohibits a sole proprietor, partner members of an LLC
(in most cases), or individuals owning more than 2% of an S corporation
from participating in the Section 125 POP, owners may still benefit
from the savings on payroll taxes by sponsoring the plan for their
employees.
What are the setup costs?
There is a setup cost to employers. The approximate costs are:
| Administrative FSA |
$1000 |
| Premium conversion |
$500 |
(Includes SPD and setup)
What are the requirements of a cafeteria plan?
-
All participants are required to be employees.
-
The participants may choose among two or more benefits consisting of cash and qualified benefits.
-
No amount shall be included in the gross income of a participant in a
IRS Section 125 plan solely because, under the plan, the participant
may choose among the benefits of the plan.
-
Deferred compensation plans are excluded.
What must an employer do to offer a cafeteria plan?
-
A plan document must be established outlining the details of:
-
Employee benefits covered through the plan
-
Participation rules
-
Annual limits
-
Election procedures
-
Eligibility and employer contribution
-
Plan year
-
A summary plan description (SPD) must be distributed to all participants
-
Ongoing compliance
-
Comply with non-discrimination requirements
|
