Health Insurance

Health Insurance

Use Cafeteria Plans to Pay for the Healthcare With Pre-tax Dollars

Google Plus One LinkedIn Print

Every employer wants to hire the best employees at market salaries. In order to maintain a great workforce and to keep employees loyal to the company, business owners look for unique benefits that make those employees want to remain with the company. One such benefit is a Section 125 Cafeteria Plan.

About Section 125 cafeteria plans

As defined by the IRS, A Section 125 Cafeteria Plan is a separate written plan maintained by an employer for employees that meets the specific requirements of and regulations of section 125 of the Internal Revenue Code. It provides participants an opportunity to receive certain benefits on a pretax basis. Participants in a cafeteria plan must be permitted to choose among at least one taxable benefit (such as cash) and one qualified benefit.

A qualified benefit is a benefit that does not defer compensation and is excludable from an employee's gross income under a specific provision of the Code, without being subject to the principles of constructive receipt. Qualified benefits include the following:

Quick Tips

  • Help your employees budget wisely. Nothing will make a plan fail more than employees who are unable to spend all the money they set aside. Since these deductions cannot be rolled over to the next year, budgeting conservatively is important.
  • Negotiate when using third-party administrators. Third party benefits administrators tend to cost more than payroll services, on average. However, they may waive set-up costs depending on what other types of benefits administration your company requires.
  • Use expert help with disability and life insurance. Paying for these insurance plans with pre-tax dollars could mean that you forfeit receiving claim payments on a pre-tax basis. It's wise to consult an expert.

The written plan must specifically describe all benefits and establish rules for eligibility and elections. A section 125 plan is the only means by which an employer can offer employees a choice between taxable and nontaxable benefits without the choice causing the benefits to become taxable. A plan offering only a choice between taxable benefits is not a section 125 plan.

How does a cafeteria plan work?

Employer contributions to the cafeteria plan are usually made pursuant to salary reduction agreements between the employer and the employee in which the employee agrees to contribute a portion of his or her salary on a pre-tax basis to pay for the qualified benefits. Salary reduction contributions are not actually or constructively received by the participant. Therefore, those contributions are not considered wages for federal income tax purposes. In addition, those sums generally are not subject to FICA and FUTA.

FSAs (Flexible Spending Accounts)

A flexible spending arrangement (FSA) is a form of cafeteria plan benefit, funded by salary reduction, that reimburses employees for expenses incurred for certain qualified benefits. An FSA may be offered for dependent care assistance, adoption assistance, and medical care reimbursements. The benefits are subject to an annual maximum and an annual "use-or-lose" rule. The maximum amount of reimbursement which is reasonably available to a participant for such coverage must be less than 500 percent of the value of the coverage. In the case of an insured plan, the maximum amount reasonably available must be determined on the basis of the underlying coverage. An FSA cannot provide a cumulative benefit to the employee beyond the plan year.

With an FSA it is a "use-it-or-lose-it" benefit. If an employee puts in $20 per month for a total of $240 and only spends $190 during the year, the employee loses $50 on December 31st. Many providers give participants a 'credit card' that can be swiped at a dentist or doctor's office and also at pharmacies. These cards do not work at general retailers or grocery stores.


A number of different companies can set up Section 125 plans including payroll services, insurance companies, third-party administrators and CPAs. Expect to pay anywhere from $300 to $600-plus annually for a Section 125 Cafeteria Plan and anywhere from $800 to several thousand dollars for an FSA, depending on the number of employees in the plan.

Ready to Compare Health Insurance Price Quotes?