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Cafeteria Plan: Definition & Overview

Updated: November 25, 2022

Numerous firms create and operate a variety of employee benefit programs that are permitted by the Internal Revenue Service all throughout the country (IRS). A section 125 plan, sometimes known as a cafeteria plan, is one of these and has been around since 1978. It has several intriguing benefits.

Read on as we take a closer look at the cafeteria plan. We’ll show you the different types, how they work, as well as lay out the advantages and disadvantages that the cafeteria plan brings.

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    KEY TAKEAWAYS

    • Employees can select from a variety of pre-tax benefits through cafeteria plans.
    • These strategies are frequently more adaptable than others.
    • Pre-tax benefits for employees include retirement plans, insurance coverage, and assistance with life events.
    • Plans for cafeterias may be more complicated and take longer to administer.

    What Is a Cafeteria Plan?

    A cafeteria plan is a benefit program for employees that offers a range of pre-tax advantages. Employees are permitted to contribute a percentage of their gross taxable income. This is prior to the calculation and deduction of any taxes.

    Plans typically offer alternatives like insurance benefits and assistance for employees. This is during various life events, like adoption. A flexible benefits plan or Section 125 plan are other names for a cafeteria plan.

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    Types of Cafeteria Plan

    The insurance choices available under cafeteria plans include contributions to health benefits savings accounts (HSAs), as well as group term life insurance, and disability insurance. Cash benefits, flexible spending accounts, and adoption assistance plans are some additional common options.

    Employees can customize a cafeteria plan to meet their unique needs thanks to flexible plan options. An employee with a big family may be better suited to a health plan with extensive coverage. Whereas the greatest option for a retiring employee may be the ability to contribute to his or her 401(k) plan.

    How Does a Cafeteria Plan Work?

    Although it has nothing to do with food, a cafeteria plan receives its name from a cafeteria. Before payroll taxes are calculated, employees can select the benefits of their choosing. This is from a pool of possibilities supplied by their employers, just like people make meal choices in cafeterias.

    As workforce diversity increases and workers look for more individualized benefits that are catered to their legal requirements, these plans become increasingly beneficial.

    Cafeteria plans are exempt from the federal income taxes computation of gross income. This is according to Section 125 of the Internal Revenue Code (IRC). No Social Security or federal taxes are subtracted. However, some benefits require employers to deduct both Social Security and Medicare taxes. Such as adoption aid benefits or group life insurance payouts that exceed $50,000.

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    Requirements of a Cafeteria Plan

    In order for a plan to be considered a cafeteria plan, it must:

    • At least one taxable benefit choice that is regarded as a component of the employee’s pay, and
    • At least one pre-tax benefit that qualifies

    Advantages and Disadvantages of a Cafeteria Plan

    The fact that a cafeteria plan reduces a person’s tax obligation is one of its key advantages. Employees minimize their gross income from which payroll taxes are deducted. This is by making pre-tax basis contributions to the plan. 

    So, the tax deductions are lower the lower the gross income is. However, they entail specific options and plans. So they can be labor-intensive to maintain and manage, costing companies money.

    Under cafeteria programs, employees may select both taxable and nontaxable benefits. Benefits that are not subject to taxation include retirement contributions and insurance alternatives. This is a significant benefit and advantage for an employee’s bottom line because it permits the person to make contributions to these plans without suffering any tax penalties.

    However, cafeteria programs have disadvantages. Particularly if the employee chooses a taxable perk like cash. In these situations, the employee will owe tax on the amount of the cash benefit received for the relevant tax year.

    Summary

    An employer-sponsored benefits program called a Section 125 Cafeteria Plan, also called my cafeteria plan, enables employees to pay for some qualified medical expenses, like health insurance premiums, before taxes. 

    It is known as a “cafeteria plan” because employees can select the healthcare options they want, such as medical, dental, vision, and other benefits, and decline the ones they don’t. This is similar to how people choose different cuisines to eat in a cafeteria.

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    FAQS on Cafeteria Plan

    Is a Cafeteria Plan Good?

    Participants who often incur costs for child care and medical concerns benefit most from cafeteria programs.

    Is a Cafeteria Plan the Same as an HSA?

    They aren’t the same, no. A cafeteria plan might allow for the funding of an HSA, also known as a health savings account.

    Who Is Not Eligible for a Section 125 Plan?

    The following people are not permitted to engage in plans:

    • Individuals who are self-employed
    • A partnership’s partners
    • Any shareholder of a subchapter S corporation with more than 2%

    How Does a Cafeteria Plan Affect Taxes?

    Benefits for adoption aid provided under a cafeteria plan are exempt from income tax withholding. But they are subject to social security, Medicare, and FUTA taxes. The cash payment is treated as wages and is liable to all employment taxes if the employee chooses to receive it instead of any eligible perk.

    How Much Does a Section 125 Form Cost?

    For employees to be able to make tax-free payroll deductions for health insurance premiums, FSA payments, and other group benefits, the IRS mandates a Section 125 Plan Document. The cost is $99.

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