What is a Cafeteria Plan?
A Cafeteria Plan is a fringe benefit plan specifically authorized by Section 125 of the Internal Revenue Code. It is a way of providing Employees with valuable benefits—where both the employer and Employees save significant amounts on taxes. Generally, Employees are given a choice to “redirect” part of their salary. Each Employee then uses the “redirected” part of his salary to purchase benefits from a “menu” of non-taxable benefits offered by the plan (hence the term “cafeteria”).
Exactly what benefits can be offered as part of a Cafeteria Plan?
The allowable non-taxable benefits include both premium only and flexible spending account benefits.
Premium only benefits
Flexible spending benefits
Health Insurance Dependent Care
Accident Insurance Assistance Programs (day care)
Group Term Life Insurance
Disability Insurance Medical Reimbursement
Dental Insurance Plan (for out of pocket medical costs)
Vision Care Insurance
Intensive Care Insurance
A plan can offer some or all of the allowable benefits. You, the Employer, choose which benefits you want to take available to your Employees. Your Employees, in turn, select the benefits that most suit their needs.
How does a Cafeteria Plan work?
Each Employee selects the benefits he wants from the Cafeteria Plan menu. The Employee “pays” for these benefits by electing to redirect his salary in an amount sufficient to pay for each benefit. Most importantly to each Employee, these amounts are redirected from the Employee’s salary before it is subject to Federal Income Tax or Social Security taxes (FICA).
How will my employees benefit from a Cafeteria Plan?
There are significant benefits for both the employer and the Employees. The primary benefit for Employees is that they are not taxed on the salary they redirect into each benefit account. Therefore, through a Cafeteria Plan, Employees can now pay for expenses with pre-tax dollar—the same expenses they were previously paying for with after tax dollars. For example, an Employee currently pays $ 150 per month for his and his dependent’s health plan. Through the Cafeteria Plan he can elect to have his salary reduced by the $150 to pay for this premium. The Employee has now effectively turned his premium expense from an after tax-expense from to a pre-tax expense with the Cafeteria Plan and thus has more disposable income each month.
Do I have to redesign my existing insurance and fringe benefit programs to take advantage of a Cafeteria Plan?
No, not at all. It will not require a change in either your group medical plan or group life plan, unless of course you would be changing them independent of any possible addition of a Cafeteria Plan. The premium payments made by Employees are still handled through your payroll department—they’re just converted to pre-tax elections, rather than after-tax Deductions.
How will I, the employer, benefit from installing a Cafeteria Plan?
Generally, you will benefit in four primary ways:
1) Cost Containment
Some Cafeteria Plans can be designed to provide employers with a cost containment on the ever-increasing expense of providing Fringe Benefits. An example of a cost containment method is a Contributory Plan. By implementing this type of plan the employer establishes a fixed dollar amount for benefits to be paid by the company to each eligible Employee. The Employee then uses this tax-free dollar amount to purchase benefits that best suit his needs from the employer’s menu of benefits (including an employer sponsored health plan.) For example, an employer allocates $100 per month per Employee for the purchase of Employee health, dental, disability, cancer or other insurance benefits available on the employer menu. Regardless of the cost of the benefit, the Employee has a $100 allowance from the employer to spend on these benefits. The Employee may choose to purchase benefits which might cost more than the allowed $100 per month, however, any amount over his allowance will be paid by the Employee via payroll Deduction. The Employer has established a fixed amount per Employee to be spent on the total benefits package. If an employer has 50 eligible Employees and contributes $ 100 for each Employee, the employer “fixes” his monthly expense for benefits not to exceed $ 5,000 (50 X $ 100), regardless of any increase of premium for benefits in his menu. This type plan gives the Employees the opportunity to select the benefits most important to their particular situation. Employees greatly appreciate this unique approach to Employee benefits.
2) Saving FICA Taxes
You will no longer have to pay FICA or FUTA Social Security taxes on the gross amount of salary redirection made by your Employees. An example can best explain the savings to you:
Total Amount of Salary Redirection by Employees annually $ 60,000 Savings in FICA at 7.65% $ 4,590 Of course the more your Employees participate, and the higher their salary redirection, the more you save each year.
3) You can participate
You personally will benefit by being a participant in the plan in the same manner as your Employees.
4) Employee morale
You also benefit by providing the Employees with a true benefit package— one that will give them more disposable income each month. An Employee’s disposable income will rise because he will be paying for these ongoing expenses with pre-tax rather than after-tax dollars. Many employers find this helps promote loyalty, motivation and increase Employee morale, which results in long-term benefits to your firm.
What type of plans are available?
The simplest plan is called a Premium Only Plan (POP). In a POP the only benefits offered by an employer are insurance products such as Employee health/HMO, dental, term life, cancer, accident/intensive care, hospital/surgical or disability. The employer selects the benefits that will be offered to his Employees on the “menu of benefits”. Each Employee then chooses which benefit(s) best suit his needs and pays for the benefits he has selected with pre-tax Deductions from his paycheck. The insurance carriers simply bill the employer for the premiums due, which are deducted from the Employee’s paycheck before taxes. There are no claims to file and this type of plan is easily understood by the Employee. The FULL PLAN with flexible spending accounts will increase the benefits offered on the premium only plan by adding (1) un-reimbursed medical expenses and (2) dependent care expenses. Each Employee estimates expenditures for his entire family for the Cafeteria Plan operating year. Then this amount will be deducted, in equal amounts, over the plan year from his paycheck before taxes are withheld by the employer. For example, an Employee, who is paid semi-monthly, estimates he will spend $ 600 on un-reimbursed medical expenses for the plan year. $ 25 ($ 600/24 pay periods) will be withheld, pre-tax, from each paycheck and the Employee will submit a simple claim form to be reimbursed for the incurred medical expense. We will process all claims and reimbursement checks making it very easy for the employer to implement a Full Plan with Flexible Spending Accounts. Many employers start with the simpler Premium Only Plan (POP) and then add Flexible Spending Accounts to the plan the second year.
What kind of non-insured medical expenses can be paid for by the Cafeteria Plan?
In general, under Section 213 of the Internal Revenue Code, ANY medical expense incurred by the Employee or family member can be placed through the Cafeteria Plan as long as it has not, or will not be covered under any health plan.
Why would my employees elect non-insured medical expenses as part of the Cafeteria Plan if I already provide medical insurance to all Employees?
The medical reimbursement plan you would offer in a Cafeteria Plan would cover expenses NOT COVERED by your group medical insurance plan. These expenses might include co-pay amounts that Employees pay as part of your group insurance, or deductible amounts that Employees pay as part of your group insurance, or deductible amounts that Employees are required to exclusively pay themselves.
Why is a choice among benefits important?
Not all Employees have the same needs! For example, some of your Employees probably have spouses who are employed on a full-time basis and are covering the entire family through their company’s group health insurance plan. This being the case, many of your Employees would not require health insurance under your company’s plan – but would prefer to purchase other insurance coverage or make contributions to pay for their dependent (day care) or medical reimbursement accounts instead. There is seldom ever a need for redundant coverages. The Cafeteria Plan enables each Employee the freedom to make the best use of their allotted monies, to meet their family’s specific needs. Cafeteria Plans give Employees the opportunity to choose the benefits most important to their particular needs—and pay for these benefits on a tax-advantage basis. Employees appreciate this unique approach, and the savings they realize as well.
Who pays for the Cafeteria Plan benefits?
Most Cafeteria Plans are set up to be funded only with salary redirection from participants. No contributions are required by the employer, although you can decide to make a contribution on behalf of all participants. The salary redirections remain as general assets of the employer. There is no trust set up to hold the funds as a pension or profit sharing plans. The only requirement is for separate record keeping for each participant’s flexible spending accounts.
When are salary redirection and benefits elected?
Your Cafeteria Plan will operate on a 12-month plan year. Prior to the beginning of each plan year, each Employee will select which benefits (if any) he wants to purchase, as well as which Flexible Spending Account(s) he wishes to fund by redirecting a portion of his salary into the appropriate account(s). Conservative estimates should be used to ensure that the Employee’s expenses will use up his entire account election during the year. We will work with each Employee to help in this important decision each year.
Once the elections are made, can the participant change his mind during the year?
The elections, once made, are irrevocable for that plan year. New elections are made prior to the beginning of each subsequent plan year. However, certain situations known as “changes in family status” can arise during the plan year; these allow the participant to change an election. These situations include:
Marriage of the participant
Divorce of the participant
Death of a spouse or child of the participant
Birth or adoption of a child (pregnancy does not constitute a change in family status)
Termination of spouse’s employment.
What happens if there is money left in the participant’s flexible spending account at the end of a year and he has no more reimbursement requests?
In that case, the participant forfeits the money in the account and the money becomes a general asset of the employer. This is the “use it or lose it” feature of a cafeteria that you may have heard of. For this reason, participants need to make conservative estimates of their reimbursable expenses prior to each plan year. Dependent child care amounts are generally easy to estimate while medical expenses not covered by insurance are harder to predict. However, experience shows that when participant is informed that he has money left in his account and the year is coming to an end, he’ll then go for the checkup he’d been putting off, or get that new pair of glasses he’d needed, etc. Communication of the Cafeteria Plan and its benefits are critical to the success of the plan. We can recommend different methods of enhancing the communication process to help make your plan more successful.
Are there any employees that cannot participate in a Cafeteria Plan?
Partners in a partnership, sole proprietors and owners who own 2% or more of a Subchapter S Corporation cannot participate in a Cafeteria Plan.
What are the requirements for installing a Cafeteria Plan?
The only requirement for installing a Cafeteria Plan is to adopt the plan, execute a plan document and have all eligible Employees make their benefit elections. Summary Plan Descriptions detailing the plan’s eligibility requirements, benefits and election requirements must be given to all Employees. There is currently no initial filing for determination letter with the IRS, as there is for pension or profit sharing plans. However, there is an annual IRS reporting requirement using Form 5500 which we prepare, that is similar to the current pension or profit sharing requirements. One of the factors most critical to the success of a Cafeteria Plan is the communication and enrollment process for Employees. If care is taken in informing Employees of the advantages of Cafeteria Plans while signing them up, there is a much greater likelihood of success.
After the plan is installed, what responsibilities will I, the employer, have?
If the plan covers flexible spending accounts, then administrative record keeping will be required for the accounts of each participant-tracking money that comes into each account through payroll Deductions and reimbursements as they are paid. Plans that provide for insured benefits only, require less administrative record keeping—your payroll department merely adjusts Employee paid premiums to pre-tax dollars rather than after tax payments. Also, participants should sign new election forms each year, deciding which Cafeteria Plan benefits they want for the upcoming plan year. We also perform this function for you at the time of enrollment!
Are there limits on how much each participant can elect to put into any single benefit?
There is a $ 5,000 limit on expenses that may be paid each calendar year for dependent care benefits for married couples who file joint returns. Other than that, there are no limitations on amounts allocated to particular benefits. However, there is a general non-discrimination requirement that says no more than 25% of the Cafeteria Plan’s reimbursements can be made to “Key Employees”. A key Employee is generally defined as someone who owns more than 5% of the company, is an officer earning more than $65,000, or owns 1% or more and earns more than 150,000. These amounts will change with IRS and Congressional COLAs.
What about future legislation that may affect the advantages of a Cafeteria Plans?
While it is impossible to predict exactly what Congress may do in the future, Congress previously considered curtailing some of the tax advantages of Cafeteria Plans and after careful consideration, decided not to place restrictions on these plans. Congress generally felt that Cafeteria Plans provide a valuable method of delivering necessary welfare benefits to Employees, including rank and file Employees. Cafeteria Plans are therefore likely to remain popular for the foreseeable future.
Should I install a Cafeteria Plan?
Many employers have been faced with the same question and have decided to implement a Cafeteria Plans! Their reasons included: They felt their Employees would appreciate the “choice” aspect of Cafeteria Plans—picking and choosing benefits most suited to their individual needs. Employees also appreciate the increase in disposable income produced by paying expenses through the tax advantage Cafeteria Plan. Employers will save considerable sums through reduced Social Security tax obligations; these savings are usually sufficient to cover all of the plan implementation and annual administration costs. In general, you can expect to spend 1/3 to 2 of your saving on competent outside administrative services. Providing Employees with this type of fringe benefit plan provides a competitive edge to the employer in attraction and retaining good Employees. Basically, employers feel these and other advantages are a significant benefit for their Employees. These employers agree that Cafeteria Plans provide a new and unique method for providing Employees with benefits they want and need in a cost-effective manner.