A Cafeteria, or Section 125, Plan is a written arrangement that offers employees a choice of cash or taxable benefits from which to choose in lieu of certain qualified benefits excludable by law from wages. These may include medical coverage (within this category, some employers may offer a selection of medical plans or managed care arrangements); death and dismemberment insurance (AD&D); short- and long-term disability insurance; life insurance and dependent care.
Employees select what they want based upon their needs. The employer allocates to each employee a sum of money to purchase the desired benefits. The employee may or may not need to set aside money to purchase various forms of coverage whose cost exceeds the employer's share.
Owing to their breadth and flexibility, such plans can serve as a powerful recruitment tool for employers. Additionally, a Section 125 plan is appropriate with an employee group desirous of various benefits. Finally, these plans can be an effective cost control measure for an employer as each benefit is priced individually, enabling employees to shop for the mix of benefits best suited to them. This has the effect of minimizing the cost of benefits that the employees tend not to need.
Because of their cost and complexity, such arrangements tend to make sense mainly for larger employers. Though beyond the scope of what candidates need to know in preparation for the CFP® examination, the complexity of these plans' tax requirements and design and administration can make them burdensome to an employer.
Cafeteria plans need to comply with IRS Section 125, lest employees become subject to taxation on the value of any taxable benefits available in the plan, even if the benefits chosen are non-taxable (e.g. medical insurance).
- Specifically, nontaxable benefits available to key employees may not exceed 25% of the total nontaxable benefits that the plan provides for all of its employees.
- The requirements of Section 125 allow for certain qualified benefits to be available in the plan. 401(k) plans are includible as are accident and health benefits; adoption assistance; dependent care assistance; group-term life insurance and health savings accounts (HSAs). Excludible are educational assistance; most qualified retirement benefits and nonqualified deferred compensation; scholarships and fellowships; Archer Medical Savings Accounts (MSAs); athletic facilities; lodging on business premises; meals and employee discounts (no additional cost services, other fringe benefits under Internal Revenue Code Section 132).
- Nondiscrimination requirements:
1. Participation: the plan must be available to employees on a non discriminatory basis
2. Benefits: plan contributions and benefits may not discriminate in favor of highly compensated employees.
In 2007, an employee may be deemed key if he or she meets any of the following criteria:
- An officer (in-fact, not merely in-title) whose annual compensation from the employer exceeds $145,000; or
- An employee owning more than five percent (5%) of the business; or
- An employee owing more than one percent (1%) of the business, and whose compensation exceeds $150,000 for the plan year.
An employee may be deemed highly compensated if he or she
- is an officer; or
- a shareholder owning more than 5% of the voting power or value of the employer; or
- any person who, in the preceding year, was an employee who received compensation of at least $90,000; or
- a spouse or dependent of any of the foregoing.
Flexible Spending Accounts (FSA)
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