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Section 125 Cafeteria Plans

The purpose of a well-designed employee benefits package is to attract and retain a strong, stable workforce. A Section 125 Cafeteria Plan helps to offset costs associated with your benefits package by allowing employees to purchase qualified benefits with pre-tax dollars. In addition, it makes it possible for an employer to realize significant savings in employee taxes. Therefore, the establishment of a Section 125 Plan offers great tax advantages for both the employee and the employer.

There are several types of Cafeteria plans defined under Section 125 of the Internal Revenue Code: the Premium Only Plan (POP), the Flexible Spending Account (FSA) and the Full Cafeteria Plan. Each plan type differs slightly in design and function. They are all, however, subject to Internal Revenue Code and require a certain level of expertise to initially set up and administer. In general, administrative costs are low and employer savings outweigh the cost.

With a Premium Only Plan (POP), an employee can make contributions for any health benefit premiums with pre-tax dollars. The health benefit premiums that qualify under a POP include such benefits as medical insurance, dental insurance, vision insurance, group-term life insurance (must be at or less than $50,000), disability insurance, and also any voluntary product. The Premium Only Plan is the simplest plan to set up and administer. Hanson Benefits offers this type of plan to its clients at no cost to the client company.

The Flexible Spending Account (FSA) is a form of Cafeteria plan that works as a budgeting tool, allowing employees to set aside pre-tax dollars for expenses other than benefit premiums. These dollars can be used for qualified expenses such as dependent daycare, health coverage deductibles, coinsurance, and co-pays not paid for by insurance. It can also be used to pay on a pre-tax basis for qualified medical treatments or prescriptions that are not covered by the employee's medical insurance. At the time of enrollment in the FSA, the employee estimates his eligible medical or daycare expenses for the year and arranges for that dollar amount to be deducted from his paycheck over the course of the calendar year.

A Full Cafeteria Plan typically offers both the POP and the FSA features and allows the employees to customize their benefits in order to meet their particular needs and objectives. The employees are given a lump sum of benefit dollars and are offered a menu from which they can choose benefit options using pre-tax dollars. A Full Cafeteria Plan is usually utilized by larger groups.

The Flexible Spending Account carries with it some issues with which an employer should be aware. The FSA plans are subject to a "use it or lose it" rule set by IRS regulations. Any unused funds at the end of the plan year are forfeited and become property of the employer. These leftover funds can then be used as the employer sees fit. However, should the funds be returned to the employees it must be done in an equitable basis to all participants.

Also, with an FSA the employer must make available to the employees the full amount of the benefit whenever reimbursable expenses occur. If an employee, for example, has designated $1,000 per year into a medical reimbursement account ($83.33 per month) and becomes eligible for reimbursement for that $1,000 in the first month of the plan year, then the total benefit must be reimbursed to the employee that first month. It does not matter that the employee has made a contribution of only $83.33 to the account. If the employee quits before the end of the plan year without having made all the contributions, the IRS rules state that the company must bear the loss.

Any form of a Section 125 Cafeteria Plan that your company may be considering offers significant tax advantages for both the employees and employers. An employee maximizes his or her take home pay by having benefit premiums and other qualified contributions deducted from each paycheck on a pre-tax basis. This offsets the cost of the employee benefits package while reducing taxable income. The Employer then can save FICA, federal unemployment (FUTA) and, in most cases, state unemployment dollars on that reduced income. Since a Section 125 plan must be in compliance with IRS regulations, it is best to consult an expert when setting up these plans. Administration of a Section 125 plan can be done in-house utilizing administration software, or a third party administrator can be hired to manage the accounting and claims. In the long term, the money saved on taxes far outweighs the administration cost of a Section 125 Plan.

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