Cafeteria Plan
The term cafeteria plan has its origins in 1978, more than 44 years ago when Congress passed the Revenue Act of 1978.1 It is officially known as Section 125 as part of the Internal Revenue Code for pre-taxable benefits offered to employees.
Before the Revenue Act, benefits were available to employees, but they were taxed. Taxed benefits were subject to Federal Insurance Contributions Act (FICA) tax, Federal Unemployment Tax Act (FUTA) tax, State Unemployment Tax Act (SUTA) tax, and other payroll taxes.
The 1978 law allows major items such group health insurance premiums, group term life insurance premiums, term life insurance, accident and disability coverage, and health and dependent care to be deducted from a person’s gross pay before it is taxed. Pre-taxed expenses add up to significant savings.2
If an employee elects to participate in an employer-sponsored health policy and pays any of the premiums, it is generally considered pre-tax.
The cost of an accident or health insurance policy an employer pays on behalf of the employee, the employee’s spouse and/or dependents are not wages and not subject to being taxed, therefore they do not affect the employee’s gross wage.3 As health care costs continue to rise, the amount of premiums you contribute each year can add up as pre-tax savings.
Example: If your gross pay is $50,000 a year, and your contributions of health care premiums is $5,000 a year, you have reduced your gross and taxable income by $5,000. In this example your gross wages will result in $45,000.
410(k) Retirement Plans
In 1981, the Treasury of the United States proposed allowing pre-tax salary deductions of fund 401 (K) retirement accounts.2 This incentive allowed for large amounts of contributions invested in a retirement plan to create an acceleration in employers and employees participating in the cafeteria plan.
Up to this point, people were still not convinced it was an advantageous program. Once financial advisors saw the value of pre-tax savings, the overall perspective changed toward participating in pre-tax benefits employers can offer.
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Employees can eliminate up to 40% in income and FICA taxes from the first dollar paid for group health premiums and out-of-pocket medical expenses.4
Group term life insurance
As part of a benefit to employees, group term life insurance may be offered to employees. If the employee pays part or all of the premium, an employer can choose to offer this as a Section 125 pre-tax benefit. Group term life insurance may not be enough coverage for the average person and family. Personal life insurance coverage in addition to a group life insurance policy is a way to financially safeguard your family.
Flexible Spending Accounts
From the pretax of the 401(K), flexible spending was created. By 1982, flexible spending was not regulated closely, and if a person did not spend the entire amount of the flex benefits, the remainder would be reimbursed back to the employee. For the IRS, this posed as a problem. In 1984, the IRS presented to Congress limitations that would prohibit year-end reimbursement back to the employee. Instead, an employee would forfeit any unused pretax benefit.
In 1981, The Economic Recovery Tax Act included a flexible spending account for dependent care. It was meant to incentivize employers to start on-site day care centers for their employees’ dependents. Instead, benefit consultants saw this as an opportunity to extend the benefits directly to employees, bypassing a company’s expense of creating an on-site childcare center.
Unfortunately, the amount a single parent can claim as pre-tax has not risen since the benefit was enacted in 1986 by Congress with a limit of $5,000. If this amount were indexed for inflation, it would cost the Treasury, resulting in lost revenue from tax payments.3
Rules continue to change and adapt as the IRS and the Treasury business leaders try to find the right balance. In 2013, employers were given the option to roll over up to $500 into the next year’s FSA.
Offer Your Employees Voluntary Benefits
Let one of our Worksite Advantage licensed agents review your employees’ insurance needs.
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Health Savings Accounts
Health savings accounts are plans that allows tax savings to accumulate. An HSA is a savings account that can be used on IRS-approved medical costs while a person is employed in the group plan. HSA also allows carryover with no penalty or loss at the end of the year. The HSA allows for portability. If you leave your employer, you do not lose the amount of money you have accumulated, but you instead can continue to use it with no expiration date.
Non-Discrimination Testing
Non-discrimination testing is a process the IRS requires to evaluate the fairness of a business or organization regarding benefit plans, including Section 125 plans. The tests determine if highly compensated employees are favored over non-highly compensated employees. This test is to ensure there is financial equality in the company or organization by giving all employees equal access to the company’s benefits.5
Elections
Cafeteria plans include an annual election which is an opportunity to sign up for benefits. Both health and dependent flexible spending accounts must hold an open enrollment because the IRS sets the benefits to a calendar year. Other pre-tax benefits such as group medical and the 401K are not tied to a calendar year, though if you want to make changes to your plans, many employers have an annual open enrollment. This annual open enrollment is normally tied to the group medical plan’s policy renewal, which typically is prior to the new year. It is during this open enrollment you can change variables like spouse and dependent coverage, voluntary benefits, and dropping or adding coverage for health insurance, HSA accounts, group life insurance, and individual insurance. This is a good time to calculate how pre-tax benefits can affect your gross pay and save you money.