Busting Major Myths about Cafeteria and Section 125 Plans

Section 125 is a part of the IRS Code that allows employees to convert a taxable cash benefit (salary) into non-taxable benefits. Under a Section 125 program employees may choose to pay for qualified benefit premiums before any taxes are deducted from their paychecks.

A Cafeteria Plan is a reimbursement plan governed by the Section 125 IRS Code. A Cafeteria Plan is a separate written plan maintained by an employer for employees that meets the specific requirements and regulations of the Section 125 IRS Code. A Cafeteria Plan is beneficial because allows the employer to reduce the employees’ gross income, which, in turn, reduces the amount the company pays in Federal Insurance Contributions Act (FICA or Social Security), Federal Unemployment Tax Act (FUTA), Workers’ Compensation, and some State taxes.

Things to remember:

  1.  Employers must have a Section 125 Plan Document in place in order for employees to participate in qualified benefits such as pretax premiums for health and/or dental insurance. This document is mandatory under Section 125 IRS Code and should be amended/restated on a regular basis.
  2. Only full-time employees who have met their Group Imposed Waiting Period (GIWP) are eligible to participate in the Section 125 plan. Partners in a partnership and over 2% shareholders in an S-corporation, are NOT eligible to participate. However, spouses and dependents cannot participate, they can receive tax-favored benefits as beneficiaries. Check with your VADA Benefits Consultant or double-check the eligibility section in your Section 125 Plan Document.
  3. Allowing supplemental benefits such as accident, cancer, and/or hospital indemnity to be pretax benefit through a Section 125 plan can open some compliance liability and should generally be avoided.
  4. Fully insured health plans are subject to Section 125 nondiscrimination testing. Section 125 nondiscrimination testing (not to be confused with the delayed ACA nondiscrimination rules) also applies to self-funded plans.
  5. Employee pretax health savings account contributions flow through a Section 125 plan. The only way to allow pretax contributions to an HSA is through a Section 125 plan. Check with your VADA Benefits Consultant or double -check that pretax HSA contributions are allowed in your Section 125 plan.

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