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 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 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 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

	without a Section 125	with a 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

Pre-tax Section 125 contributions	$ 1,000
Number of employees	x 20
Total employee contributions	$20,000
FICA factor	x  .0765
Estimated annual FICA savings	$1,530

 

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 must an employer do to offer a cafeteria plan?

We've partnered with Benefit Strategies, LLC to help you meet your Section 125 plan needs under health care reform. For eligible employers, this service is available at no additional cost.

Learn how we can help you set up a Section 125 plan