A Section 125 plan, or cafeteria plan, is a popular employee benefit program. Cafeteria plan benefits, as the name implies, allow employees to choose the type of benefits they want so they don't have to pay for or opt into benefits they'll never use. Cafeteria plans are highly customizable, leveling the playing field for small and mid-size businesses to compete with large firms that offer comparably larger benefit packages.
Cafeteria plans include flexible spending accounts (FSAs), health, life, and disability insurance, dependent care assistance, and other benefits. Unlike other employee benefit plans, Section 125 plans are customizable, and employees can get more value out of their participation. Here's what Texas employers need to know about setting up a Section 125 plan and why it would be advantageous to do so.
One of the biggest draws of a Section 125 plan is that it is a tax-favored account similar to a 401(k), except there is no deferral to retirement. Employees make pre-tax contributions and save on income and FICA taxes. This is on top of saving the money they'd otherwise spend out of pocket with post-tax money on childcare expenses, medical supplies, and services not typically covered by insurance.
Employers save money as well, as they don't have to contribute their share of FICA on the pre-tax compensation going into the Section 125 plan.
Employees are happier and more likely to stay if they have cafeteria plan benefits. Traditional core benefits like health insurance are also an attraction and retention factor, but employees who are already insured through a spouse, parent, or government program are not likely to opt in. If there is a designated program for childcare assistance, it can make employees without children feel less valued if they don't have access to an equally valuable benefit.
Cafeteria plan benefits increase employee satisfaction, equity, and inclusion. When employees get to choose the benefits most valuable to them, customized to their personal needs regardless of family status and other aspects of their lives, it decreases turnover. Employees who are happier and more satisfied are less likely to leave.
According to SHRM, there are more employee benefit program types than ever before. More than 200 types have been identified, representing a 23% increase from 2023.
Aside from the core benefits like health insurance, retirement plans, and paid time off, there are also educational and dependent care benefits. Benefits are also becoming more niche, with many employers now offering pet insurance, nutrition counseling, free meals, menopause support, and other programs designed to attract and retain a talented and diverse workforce.
A comprehensive benefits package makes employers of all types and sizes more competitive. When employees feel valued and employers give them a reason to stay, turnover decreases and productivity increases.
As the employee benefit program landscape evolves, the flexibility and tax advantages of a Section 125 plan are unparalleled. Many of these new niche benefit programs may have unclear tax status or be outright taxable. Offering a large variety of benefits attracts highly qualified professionals who have several options, but the customization and tax-favored status of Section 125 plans make them one of the most valuable retention tools available to employers.
As expectations for more niche benefits arise to keep firms competitive and attract diverse employees, the IRS may also expand the types of benefits eligible for Section 125 plans in due time.
Section 125 plans empower employees to choose the benefit programs that best fit their needs. Customizable cafeteria plan benefits can include:
Doctor and dentist visits, eyeglasses, hearing aids, and other medical, dental, vision, and mental health services are eligible for reimbursement under a Section 125 plan. These benefits even include dual-purpose items and services like sunblock, over-the-counter medications, compression socks, massage therapy, and more, all of which are tax-free.
Employees must elect at least one taxable benefit, usually cash but it can be a taxable benefit program, and one eligible benefit such as health insurance. This enables them to get the most value out of the plan by participating in as many programs as they choose and opting out of the ones they don't need. Employees who already have health coverage can choose other types of insurance that are normally inaccessible at the individual level, such as group term disability insurance.
When implementing a Section 125 plan in Texas, there are IRS guidelines that must be followed in order to keep the plan's tax-favored status. These compliance measures include:
Implementing a Section 125 plan requires several stages of planning, compliance checks, and ensuring there is an ongoing recordkeeping and monitoring system in place. Affiliated HR & Payroll can tailor the plan documents and compliance solutions to your organization.
Ready to maximize your tax savings and boost employee satisfaction? Contact Affiliated HR & Payroll today to learn how we can help you implement a cafeteria plan that fits your business needs and enhances your employee benefits package.