A Section 125 Plan is an employer-provided benefit where the employee can choose from a range of different benefits and pay for them with pre-tax dollars.  Section 125 refers to the Internal Revenue Code section that governs the administration of these plans.  They are also called “cafeteria” plans because, like a cafeteria, the employee has his choice from a full menu of different options.

There is a wide range of benefits available to employees through the Section 125 Plan.  Health, life, and dental plan are the usual suspects, but employers can also run through products such as disability insurance, and funding for Health Savings Accounts (HSAs), cancer insurance, and eye care, among others.

There are also rules about what types of employees can participate in a 125 Cafeteria Plan.  Sole proprietors and 2% shareholders of S Corporations can’t for example.  The employer should also take pains to ensure that the 125 Cafeteria plan does not discriminate in favor of “highly compensated” or “key” employees.  Both of these terms are extensively defined by the IRS, but essentially a plan can’t provide the lion’s share of benefits to officers or owner-employees without facing adverse tax consequences.

Why bother having a 125 Cafeteria plan?  Tax savings is a big incentive.  Cafeteria plans allow employees to pay for benefits on a pre-tax basis.  That is, the premium is deducted from the employee’s taxable income, thereby reducing his Federal and often State withholding, FICA, and Medicare tax.  It’s the net effect of a pay raise that didn’t cost the employer a thing.  Depending on the state where you’re located, workers compensation might be lowered as well.

Even the Employers receives a benefit:  that reduction in the employee’s taxable income also translates to lower employer share of FICA and Medicare taxes, and lower FUTA taxes.  There’s also a morale boost that comes when the employee realizes that a smorgasbord of benefits are available to him.

Cafeteria plans allow employers to offer benefits that they could not otherwise afford.  And because the benefit payments are pre-taxed, it costs the employee less to “buy” the benefits than it would if s/he did it on his or her own.

The biggest downside of Section 125 Cafeteria plans are the administrative requirements.  You’ll need to prepare a plan document and keep it up to date to avoid running afoul of the IRS.  You will probably want to get some legal and administrative help to keep the plan running smoothly.  There is also a cost involved; the National Conference of State Legislatures estimates that an employer will pay up to $100 per employee to set up and administer a Section 125 Cafeteria Plan; the tax savings, however, can easily cover this cost.

A Section 125 Cafeteria Plan can be a great tool to expand your employees’ benefit options while also benefiting your company.  It’s a great benefit to employees and will immediately increase their take home pay.  Many companies are already running the premiums through pre-tax but are legally required to have a Section 125 plan document.  There are many professional administrators and document companies that can create the document and assist in the compliance and maintenance of the plan for a reasonable fee, obviously www.taxfreepremiums.com offers a turn-key and compliant solution to automate the process.