To control healthcare costs, some employers are turning to tax-advantaged medical reimbursement accounts. In fact, these types of account-based health plans are becoming an increasingly popular option among employers. As organizations evaluate using Health Reimbursement Arrangements (HRAs) and/or Health Savings Accounts (HSAs), two terms are often thrown around: “Section 105 Plans” and “Section 125 Cafeteria Plans”. Though closely related, and often confused, they are two different types of plans.
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What is a Section 125 Cafeteria Plan
Though Section 125 Cafeteria Plans are quite common, many don’t know them by name.
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 or plan 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.
It’s called a Cafeteria Plan because, much like choosing from a menu, an employer may provide a selection of benefits from which the employee can choose from.
Common examples of Section 125 Cafeteria Plans include:
- Contributions to a Health Savings Account (HSA)
- Health Flexible Spending Accounts (FSAs)
- Premium Only Plans (POPs)
- Dependent Care Flexible Spending Accounts
To summarize, under Section 125 of the IRS Code, a Cafeteria Plan offers a way for employees to pay for qualified contributions to insurance premiums and medical spending accounts with pre-tax dollars. These are often offered as an alternative to, or alongside, an employer’s group health insurance plans.
What is a Section 105 Plan
Next, there are Section 105 Plans. Just like Section 125 Plans, Section 105 Plans are named after the tax-code (IRC Section 105) that allows tax-free reimbursements for expenses incurred for medical care as defined in Section 213(d), including reimbursement for individual health insurance expenses.
Section 105 Plans are employer-funded and are used in a variety of ways.
Common examples of Section 105 Plans include:
- Self-Funded (Self-Insured) Health Plans
- Health Reimbursement Arrangements (HRAs)
- Medical Expense Reimbursement Plan (MERP)
To summarize, Section 105 Plans offer a way for employers to provide employees tax-free reimbursements for qualified medical and health insurance expenses. Due to the tax-free nature of the plan and the built-in control regarding budget, many organizations turn to Section 105 plans to save money. Fortunately, when done correctly the cost savings still come with a valuable employee benefit that helps with hiring and retention strategies.
Conclusion
Section 125 Cafeteria and Section 105 Plans are similar but have unique advantages. Both plan types allow employers to provide pre-tax contributions to medical and health insurance expenses. There are also key differences in structure, funding, and qualified healthcare expenses. Oftentimes, the benefits of these plans can be even further expanded by combining plans under each type such as combining an HRA with an HSA or FSA.
This article was originally published on July 15, 2015. An updated version was posted on January 13, 2021.
