Section 125 of America’s tax code states that a cafeteria plan can have employees redirect pre-tax salary toward medical and child-care needs. As this money is tax-free, an employee owes less taxes and takes more money home. Further, employees avoid dealing with FICA. Many employees forego cafeteria plans, usually because the administration often sees them unprofitable and unmarketable. Use the tax code for your business and you broaden your employee benefit package and boost your profit margins.

Cafeteria Plans Offer Several Flexible Benefits:

Premium Only Plans (POP)s.

Employees can put some pre-tax salary toward employer-sponsored health and welfare plans. This means favorable tax treatments beyond existing benefits and is how most companies handle payroll. POP plans are the easiest way to optimize a Section 125 plan and require little maintenance.

Out-of-Pocket Medical Costs (FSAs).

FSAs les employees fund medical procedures on a pre-taxed basis to cover out-of-pocket costs their insurance will not. The average working American spends over $1,000 a year on these benefits; FSAs means employees have more money to keep.

Dependent Care Flexible Spending.

The dependent care FSA is appealing to employees caring for others. Few employees take advantage of these and may not know how much they will save on taxes. Employees can withhold up to $5,000 a year on pretax salary for this while working, looking for work or enrolled in classes full time. Further, this sort of plan means employees can cut child-care costs by 20-40%.

The best part? Your employees are already paying out of their own pockets after taxation. Cafeteria plans allow them a way to save the money they already spend.

How It Works

Before the plan begins each year, an employee discerns their expected out-of-pocket expenses for medical and dependent care for the year. This amount is then taken out of paychecks over the year and deposited into the FSA. Once a plan goes into effect and barring a “change in family status,” the employee is restricted in how they can change or rework his section 125 agreement. Employees pay out-of-pocket costs upfront, then submit a claim and documentation to plan administrators. This is then taken from the account and arrive as a check.

Employer Benefits

  • Every dollar handled by a 125 plan diminishes payroll. This means that money passes FICA and premiums. This alone can contribute a 20% savings on every dollar in the plan.
  • It can soften the blow of premium increases to employees.
  • You can use the tax savings to invest in retirement plans. FSAs allow employees to cut costs on daily expenses, freeing up more income to go toward 401(k) plans and upping participation.

Employee Benefits

  • Less taxable salary. More take-home pay.
  • A greater deduction on dependent care cases than traditional tax credits.
  • Less impact from insurance spikes.

Procedures to Comply With Section 125

  • Establish a plan document, outlining how employee benefits are covered, participation, limits, election procedures, eligibility, what employers contribute and the plan’s year.
  • A summary plan description (SPD) must be given to all participants. Section 104(b) of the Employee Retirement Income Securities Act of 1974 (ERISA) states that distribution must occur either 90 days prior to an employee becoming a participant or within 120 days of the plan becoming governed by ERISA. Participant beneficiaries must also receive a description of the plan within 90 days after being eligible. The SPD clarifies plan specifics, how to file claims and details on plan sponsorship and administration. Lastly, the plan must be filed with the Department of Labor within 120 days before it goes into effect.
  • Ongoing compliance with anti-discrimination legislation.

To reiterate, corporate cafeteria plans are cheap to establish and maintain. Most employers can cover the implementation costs in the plan’s first year, possibly even within the first month.


Richard is an experienced tech journalist and blogger who is passionate about new and emerging technologies. He provides insightful and engaging content for Connection Cafe and is committed to staying up-to-date on the latest trends and developments.