A Cafeteria Plan Gives Employees Choices about Their Benefits

Employees May Select among a Variety of Nontaxable Benefits Options

A cafeteria style benefits plan takes care of employees at any stage of their lives.
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Looking for a way to customize your benefits plan to the needs of your individual employees? A cafeteria style benefits plan is an employee benefits plan that allows your employees to choose among a variety of options to create a benefits package that best meets their needs and those of their family.

Cafeteria style plans provide a special exception to federal income tax rules that apply to an employee’s earnings.

In a cafeteria style plan, employees are allowed to select among a variety of nontaxable benefits and cash.

Benefits to Employees

In a cafeteria style plan, an employee generally receives a certain number of dollars from the employer to purchase particular components of a benefits plan. This enables employees to purchase benefits, such as health insurance, with pretax dollars.

Cafeteria style plan options can include various levels of health insurance plans and other insurance options such as short term and long term disability insurance, and group term life insurance. 401(k) plan contributions for retirement, dependent care assistance, adoption assistance plans, and contributions to Health Savings Accounts (HSAs) are several additional benefits a cafeteria style plan can provide.

This provides employees with more take home pay and several additional benefits. The advantage of a cafeteria plan is that employees have benefits plan options.

For example, a young employee with no health problems might opt to spend cafeteria plan dollars on a minimal health plan.

An employee with four family members might choose to spend the cafeteria plan dollars o  a health plan with more comprehensive coverage. The employee without a family might choose to spend his or her benefits dollars for investments in a retirement plan.

Regulation of Cafeteria Style Plans

Cafeteria plans are governed by Section 125 of the Internal Revenue Code. No matter the goal of the employer’s cafeteria plan, the plans are, according to Gregory Boop,

“named after Title 26, Section 125 of the United States Code where 'cafeteria plans' are specifically excluded from the calculation of gross income for federal income tax purposes.

"125 plans allow employees to contribute pretax dollars into the plan. Contributions toward plans are not subject to federal, state, or social security taxes. The contributions are placed into an account the employee can use to pay for allowed expenses (e.g., premiums for health insurance, dependent care costs, medical supplies). Since no federal, state or social security taxes are taken out and the dollars are not included as gross income, the employee saves anywhere from 27 - 50% on these purchases."

When the Employee's Choices Exceed the Amount of Money

In a typical cafeteria plan, an employee might exceed the number of dollars allowed by the employer with the benefits plan choices he or she made. In these cases, the employee pays a part of the premium for his or her chosen benefits, so the cost to employers is lower.

For example, an employee with health problems or an employee who is age 55 and above might choose to buy up to a more comprehensive health plan that covers more services.

Work with Benefits Professionals

In all cases, working to provide employees with a cafeteria style plan for benefits deserves the assistance of a benefits plan professional who can advise the employer about options. Between the complexity of the U.S. tax code and the predictable changes in laws, employers should seek assistance.

Whether you are large enough to employee a compensation and benefits coordinator or you rely on the assistance of trusted external advisors, I recommend getting advice. Employers should not go this route on their own.

The complexity of the tax code is such that you need professional assistance to devise a cafeteria plan that is legal and that benefits both the employer and employees.

Disclaimer – Please Note:

Susan Heathfield makes every effort to offer accurate, common-sense, ethical Human Resources management, employer, and workplace advice both on this website, and linked to from this website, but she is not an attorney, and the content on the site, while authoritative, is not guaranteed for accuracy and legality, and is not to be construed as legal advice.

The site has a world-wide audience and employment laws and regulations vary from state to state and country to country, so the site cannot be definitive on all of them for your workplace. When in doubt, always seek legal counsel or assistance from State, Federal, or International governmental resources, to make certain your legal interpretation and decisions are correct. The information on this site is for guidance, ideas, and assistance only.