A 125 Plan, also called a Cafeteria Plan, is a popular employee benefit program. Named after Section 125 of the tax code, cafeteria plans offer a variety of tax-free benefits to employees. In exchange for the benefits, employees don't pay federal income or FICA taxes on their contributions to the plan. These benefits can include health and life insurance, adoption assistance, childcare expenses, and medical expenses.
Employers also benefit from cafeteria plans. They are an extremely attractive benefit for attracting top talent, and employers don't have to pay their share of FICA taxes on the employee pay allocated to the cafeteria plan. For small businesses in particular, cafeteria plans are an excellent and affordable alternative to paying for employees' health insurance.
Here's what Lone Star State employers need to know about how to set up a Section 125 cafeteria plan in Texas.
Step-by-Step Guide to Setting Up a Section 125 Plan
125 cafeteria plans are governed by a written plan document, per IRS mandates. Only certain benefits are permitted under a cafeteria plan, and there are additional compliance requirements. The following steps must be taken to put the governing document together:
Step 1: Assess Your Needs
First, you need to evaluate your employees' needs and the reality of your business environment.
Most people need health insurance through their jobs. However, if most of your employees have health coverage through a spouse, parent, or government program, a cafeteria plan would make more sense because they can choose different types of insurance or other benefits. As the name implies, FSAs allow employees to choose their benefits "cafeteria-style" regardless of where their medical coverage comes from.
125 cafeteria plans can cover many medical items not normally covered under insurance, like eyeglasses, compression socks, massages, and other expenses that quickly add up from the employee's post-tax pay, which is why they're such an attractive benefit. Cafeteria plans can also have even more benefits, such as dependent care assistance. Find out what type of benefits your employees would value the most under the plan, and determine which ones will become reality.
Step 2: Design the Cafeteria Plan
The structure of the cafeteria plan should be outlined. Who is eligible? What types of benefits are offered, and how is eligibility determined for each of them? Outline how much employees must contribute in order to participate.
Step 3: Create Plan Documents
In order to set up a 125 plan, the following cafeteria plan documentation is required:
- Plan Document
- Summary Plan Description
- Election Forms
The plan document is the outline of the 125 plan that must comply with IRS guidelines. It must outline the benefits offered and eligibility criteria, along with other crucial plan details like enrollment deadlines and procedures. You must clearly explain to employees, both in the plan document and in other communications, when their annual enrollment opportunities are and if any special enrollment periods apply.
The plan document must be made available to employees whenever they request it.
The summary plan description is required under the Employee Retirement Income Security Act (ERISA). It applies to all benefit programs offered by the employer. There is a section in the summary plan description dedicated to cafeteria plans, and it should provide detailed information about the 125 plan's benefits offered and rules for participation and eligibility.
Election forms must be customized to the organization and benefits offered under the 125 plan. These forms detail the employee's identity, the year in which the election applies, and the benefits chosen. The election form should also detail the monthly premium for each benefit that is to be deducted from the employee's paycheck pre-tax.
Step 4: Obtain Necessary Approvals
Depending on the size of the organization and other factors, approval may be required to establish a cafeteria plan. Key stakeholders, such as executives, investors, and shareholders, may need to approve this decision depending on the language in any operating agreements or charters.
If you are unsure whether any of these parties require approval, it is best to obtain legal counsel.
Step 5: Implement the Plan
Employees need to become aware of the cafeteria plan, its benefits, and how they can opt in. The plan documents should thoroughly outline all of these details, but it's also helpful to create additional easy-to-understand employee-facing materials.
Written internal communications like emails, memos, and knowledge bases should explain how employees can enroll in the cafeteria plan and what the enrollment process entails. Employees should have educational material about the plan that they can access at their own pace, in addition to one or two company-wide meetings explaining how plan participation works.
Step 6: Ensure Compliance
The IRS administers tax law, and ERISA is administered through the Department of Labor, which governs employee benefit programs.
ERISA governs virtually all private employers in the US and programs deemed "welfare benefit plans". Cafeteria plans and other wellness-related benefits like dental and vision benefits fall into this category. However, there is a safe harbor exemption for voluntary plans where the employer has minimal involvement and does not make contributions to the plan. Employers that make these contributions are subject to ERISA regulations.
ERISA requires employers to take their fiduciary duty seriously and furnish certain information to employees, outlined in their comprehensive employee benefit guide.
IRS regulations mandate certain conditions to keep the cafeteria plan's tax-favored status. There must be a written plan document that is compliant with IRS guidelines and made available to employees if they request it. Form 5500 or 5500-SF must be filed every year for the 125 plan, and any other benefit plans require their own form. Forms 1094-C and 1095-C may also be required if you are subject to Affordable Care Act mandates to report information on 125 plans.
The IRS also has a non-discrimination mandate. Since ranks of employees may have different benefits available to them as part of their overall compensation, 125 plans are required not to discriminate in order to stay tax-favored. Rank-and-file employees at lower pay tiers must be just as eligible to participate as highly paid employees. Non-discrimination must be evident in the eligibility guidelines and benefits available to participants.
Step 7: Administer and Monitor the Plan
Once the plan is implemented, there should be a system to monitor and routinely audit the plan. Affiliated HR & Payroll can assist with the procedures and tools to do so, such as recordkeeping systems and guidance on what to watch for in plan audits.
Common Challenges and Solutions
While 125 plans are an excellent benefit that attracts quality talent and provides cost savings for both the employer and employees, they also have several challenges.
Setup and administration fees to start a cafeteria plan can be onerous, to the point that employers feel it isn't justifiable. However, these high upfront costs even out over time by improving the employer brand and attracting better employees while decreasing turnover.
Choosing which benefits to offer is also a challenge. If there aren't enough diverse choices, employees will be disinterested and make those high upfront setup costs moot. The best way to handle this is to gather employee input on the types of benefits that would be most valuable to them. Not only does it directly pinpoint which benefits would ensure the most plan participation, but employees feel valued and listened to.
Benefits of Partnering with Affiliated HR & Payroll
Affiliated HR & Payroll offers a host of solutions and compliance consulting to assist businesses in setting up and managing their cafeteria plans. We can help you establish your plan documents so they are IRS and ERISA-compliant, find attractive benefits, and implement a recordkeeping and monitoring system.
Need help setting up your Section 125 Cafeteria Plan? Contact Affiliated HR & Payroll today for expert guidance and support to ensure a smooth implementation process.