A Section 125 plan provides tax benefits to your workers and can help reduce the impact of rising health care costs. With these costs representing a significant portion of the average American’s expenses, offering a way to reduce them and help employees plan ahead can be attractive incentives. One such benefit, the Section 125 health plan, often referred to as a cafeteria plan, provides significant tax advantages for both employers and employees.
Thus, this article delves into the real financial impact of ignoring Section 125 health plans and why integrating them into your benefits package is a strategic move.
What are Some Common Types of Section 125 Plans?
Below are some common types of Section 125 plans,
- Premium Only Plan (POP)
A Section 125 Plan lets employees pay certain insurance premiums with pre-tax dollars. However, the plan itself is not insurance, and employers still have to offer group health insurance and other benefits separately.
POPs are the most common component of all Section 125 plans because it is a requirement in order to allow employees to contribute to their healthcare benefits pre-tax. It is most often used in conjunction with Flexible Spending Accounts (FSAs) and Dependent Care Assistance Plans.
These Section 125 plan benefits can be applied to premiums for group insurance products such as:
- Medical
- Dental
- Vision
- Disability (as long as benefits are taxed upon receiving)
- Term Life (up to $50,000 in coverage, as long as benefits are taxed upon receiving)
A premium-only plan can include a “cash-in-lieu of benefits” provision for employees who don’t want coverage under the group plan (see more below). Employees who are enrolled in another group health plan (like a plan from a spouse or parent) can choose to receive a fixed amount of cash instead. Unlike premium payments, this dollar amount is taxed.
- Flexible Spending Account
An FSA is a special account into which you can deposit pre-tax money to pay for IRS-eligible, out-of-pocket medical and dependent care expenses.
- Simple Cafeteria Plans
Simple cafeteria plans provide employers with 100 or fewer employees a safe harbor from certain nondiscrimination requirements in exchange for employer contributions to each eligible employee’s benefits.
- Full-flex Plans
With a full-flex plan, employers make contributions for all plan-eligible employees. Employees then use those contributions to pay for various benefits—this is also more generally known as a “cafeteria plan.” They can usually also make pretax contributions toward any benefit that your contributions don’t fully cover.
What’s the Real Financial Impact of Ignoring Section 125 Health Plans?
- Increased Tax Burden for Employees
Without a Section 125 plan, workers pay for qualified health insurance Section 125 premiums and expenses using after-tax dollars. This results in them being taxed on a greater gross income, which translates to lower take-home pay. For example, a worker who makes $50,000 per year with $5,000 in health insurance premiums would pay about $1,200 more in taxes without a Section 125 plan.
- Higher Payroll Taxes for Employers
Employers also have financial disadvantages. By failing to adopt a Section 125 plan, employers lose payroll tax savings in the form of Social Security and Medicare tax reductions. The reduction in taxable payroll can lead to considerable yearly savings for the business.
- Competitive Disadvantage in Employee Retention
Offering a Section 125 plan enhances your benefits package, making your company more attractive to current and prospective employees. Without it, you risk higher turnover rates and increased recruitment costs, as employees may seek better benefits elsewhere.
How Can Employers Set Up a Section 125 Health Plan?
For a Section 125 health plan to be compliant with regulations, certain documents are required. These detail the legal and employer-specific aspects of the employer’s benefit plan, which are required under both the Internal Revenue Code and, oftentimes, the Employee Retirement Income Security Act (ERISA). A broker, a benefits attorney, or even a third-party administrator should be able to assist with providing these documents.
Because many employee benefits are covered by ERISA, they require a summary plan description (SPD). The purpose of this is to inform employees about the various aspects of the benefits plan being offered. The law requires that the SPD be provided to all eligible employees. Employers can technically write their own plan document, but it’s easier to consult a health insurance broker or an attorney who knows the compliance requirements.
The employer’s plan document must include:
- A description of the benefits offered by the plan
- Eligibility and Participation Rules
- A provision that elections can only be made during open enrollment (unless the plan allows for benefits election changes due to a change in status)
- The pre-tax contributions limit
- Details on how or if employer contributions are made
- The plan year
Depending on the benefits offered, there may be additional information that is required.
The plan document must also state that only employees are eligible to participate in the plan. Employers, spouses, and dependents cannot contribute to the plan. However, a participating employee’s spouse and dependents can receive benefits through the plan as long as the employee is enrolled (note: there may be certain exceptions under retirement benefits plans).
What are the Benefits of Section 125 Plans?
There are many advantages that your business and employees gain when you offer these plans:
- Tax Flexibility
Cafeteria plans help employees maintain greater control over their taxable income and can be a wonderful tool for tax planning. Because employees can determine the amount they’d like to contribute, they can balance what they’re able to afford with the tax benefits they wish to receive.
- Tax Savings
POP and FSA plans help employees save money on federal and state taxes while reducing their contributions to FICA and Medicare. They can do so while making funds available to cover out-of-pocket costs they‘re already paying for.
- Reduced Payroll Tax Liability
Companies can reduce their tax burden by contributing less to payroll tax withholding, FICA and FUTA. These savings are typically sufficient to offset the expense of implementing the plans because the Section 125 deductions are regular and have long-term savings.
It’s your decision to decide if the advantages of having cafeteria plans are worth the expense. There are also decisions that employees must make when deciding if they should sign up for one of these plans, which might cause them to hesitate. It’s a good idea to educate your employees on how to receive the most benefit before they sign up.
Ready to Enhance Your Employee’s Section 125 Health Plan?
Ignoring the implementation of a Section 125 health plan can lead to unnecessary financial strain for both employers and employees. Thus, implementing a Section 125 plan can lead to significant tax savings and improved employee satisfaction. Don’t let your business miss out on these advantages.
Contact Lumara Plan today to learn how we can assist you in setting up a compliant and beneficial Section 125 plan tailored to your company’s needs.
