What is the Difference Between a Cafeteria Plan and a Section 125 Plan?
They are pretty much the same. The two terms are used interchangeably. A cafeteria plan (which includes Premium Only Plans (POPs) and Flexible Spending Accounts) is an employee benefits program designed to take advantage of Section 125 of the Internal Revenue Code.
The cafeteria plan allows employees to pay certain qualified expenses (such as health insurance premiums) on a pre-tax basis, thereby reducing their total taxable income. Funds set aside in Flexible Spending Accounts (FSAs) are not subject to federal, state, or social security taxes.
Components of Section 125/Cafeteria Plans
- Premium Only Plan (POP): Employers may deduct the employee’s portion of the company sponsored insurance premium directly from the employee’s paycheck before taxes are deducted. A POP is the simplest type of Section 125 plan, and is relatively low maintenance once it has been set up.
- Flexible Spending Accounts (FSA): In an FSA, employees may set aside on a pre-tax basis a pre-established amount of money per plan year. The employee can use the funds in the FSA to pay for eligible medical, dependent care, or transportation expenses. The plan year is one full year (365 days) and generally begins on the first of a month. Many employers design their flexible spending plan to run on the same plan year as their insurance program.
Cafeteria Plans are qualified, non-discriminatory benefit plans, meaning a discrimination test must be met based on the elections of the participants combined with any contribution by the employer.
To ensure compliance, the Internal Revenue Code sets forth testing requirements to make certain that Cafeteria Plan benefits are available to all eligible employees under the same terms, and that the Plan does not favor highly compensated employees, officers, and owners. Thankfully, there is a special Safe Harbor test (that is much easier to satisfy) if you only offer a POP. Contact your Account Manager if you have questions about non-discrimination testing.
1. A cafeteria plan is the only method under which employees can contribute to the cost of group health coverage on a pretax basis.
2. The IRS requires that the cafeteria plan be in writing. Employers must have a written plan document.
3. If there is no plan document in place, the plan is not a cafeteria plan and an employee’s election between taxable and nontaxable benefits results in gross income to the employee.
Download the attached PDF to learn more.