How Section 125 Cafeteria Plans Work

July 14, 2014

Most working Americans have access to a Section 125 Cafeteria Plan at some point during their working career, yet many do not take full advantage of them. When utilized correctly, a Cafeteria Plan can increase take-home-pay without any change in expenditures. This article provides an overview of how Section 125 Cafeteria Plans work. 


What is a Section 125 Cafeteria Plan?

A "Cafeteria Plan" (see Section 125 of the IRS Code) is a benefit provided by an employer which allows an employee to contribute a certain amount of his or her gross income to a designated "account" before taxes are calculated. This "account" can be used to reimburse the employee for certain types of insurance premiums, medical, or dependent care expenses throughout the plan year or claim period as the employee incurs qualified expenses.  

Essentially, a Section 125 Cafeteria Plan allows an employee to reduce their gross income, effectively reducing the amount they pay in Federal, Social Security, and some State taxes.  This amounts to a savings of between 25% and 40% of every dollar they contribute to the plan. The employer also realizes savings on FICA withholding tax for each participating employee.

How does the Affordable Care Act Impact Section 125 Cafeteria Plans?

The Affordable Care Act limited what type of health insurance premiums may be used with a Section 125 Cafeteria Plan. Specifically, Health Insurance Marketplace (Exchange) plans are not a qualified benefit under Section 125. Because of this change, most employers now use Section 105 Plans for individual health insurance policies. 

Read more: Why Section 105 Plans are Better Than Section 125 Plans (Post-2014)

Common Examples of Section 125 Cafeteria Plans

What questions do you have about how Cafeteria Plans work? Leave a comment or question below.

Photo credit: Flickr, mikecogh

Wondering how you can help your employees pay for health insurance?
The qualified small employer HRA can help.

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