Question

Describe what how cafeteria plans work. What is the advantage of them for the employee & the employer?

Answer 1

CAFETERIA PLAN

A cafeteria plan is an employee benefit plan that allows staff to choose from a variety of pre-tax benefits. Employees can contribute a portion of their gross income before any taxes are calculated and deducted. Plans normally include options such as insurance benefit and benefits that help employees with various life events such as adoption. A cafeteria plan is also referred to as a flexible benefits plan or Section 125 plan

HOW CAFETERIA PLAN WORKS

A cafeteria plan gets its name from a cafeteria but has nothing to do with food. Just as individuals make food selections in a cafeteria, employees can choose the benefits of their choice before payroll taxes are calculated from a pool of options offered by their employers. These plans become more useful as diversity within workforces continues to grow and employees seek more personalized benefits that are tailored to their needs.

Cafeteria plan selections include insurance options such as health savings accounts (HSAs) contributions, group term life insurance, and disability insurance. Other popular selections include adoption assistance plans, flexible spending accounts, and cash benefits.

Flexible plan selections allow employees to tailor a cafeteria plan to their specific needs. For example, the best selection for an employee reaching retirement may be able to make contributions to his or her 401(k) plan, while an employee with a large family may be better suited to a health plan with broad coverage.

Section 125 of the Internal Revenue Code (IRC) specifies that cafeteria plans are exempt from the calculation of gross income for federal income tax purposes. No federal or Social Security taxes are deducted. However, some benefits—like group life insurance benefits that exceed $50,000 or adoption assistance benefits require employers to withhold both Social Security and Medicare taxes.

Benefits to employers

Every dollar ran through the 125 plan reduces an employer's payroll. Therefore, you don't have to pay FICA or workers' comp premiums on those dollars. In many cases, this savings can add up to as much as 20 percent of every dollar being passed through the plan.

Implementing a cafeteria plan can "soften the blow" of premium increases to employees. For example, let's say a company's medical premiums are raised 10 percent for the year--a-not-unheard-of amount. Let's assume that 10 percent increase takes the premium for one of the company's employees, including their dependents, from $800 to $880 per year. Let's also assume the employer pays for 100 percent of the employee-only rate, which is $200 in this example, leaving the employee responsible for the cost of his or her dependents ($600). With a 10 percent increase on the portion the employee pays, the employee is now paying an additional $60. If these additional costs are run through a POP plan, an employee in the 25 percent tax bracket would have an increase of just $45, rather than $60.

Employees can use tax savings to invest in retirement plans. By using an FSA, your employees can save money on their everyday expenses, thus freeing up more of their income to be allocated to their 401(k) account, which increases participation.

Benefits to employees

Participating in a cafeteria plan reduces an employee's taxable salary and increases the percentage of their take-home pay, thus increasing their spendable income.

They receive a greater deduction on dependent care expenses than what's offered by a traditional tax credit at the end of year.

There's less of an impact on employees from insurance increases, such as premiums, co-pays, deductibles and so on. One of the most common ways for employers to keep benefit costs down is to simply lower the benefit levels of their plan offering. While this save you money on your premiums, your employees are then faced with greater deductibles, higher co-pays, higher prescription amounts and so on. Through the use of an FSA, employees can set aside money to cover these increased amounts, which lessens their out-of-pocket costs because they're setting aside tax-free dollars.