Flexible benefit plans.

In recent years, flexible benefit plans have become an integral part of many employers' benefits programs. Participation in these plans continue to rise. However, the groundwork for these plans has been set for nearly 30 years, as they were made possible through the Revenue Act of 1978.

That federal law did a number of things: It reduced individual income taxes; hiked the personal and standard deductions and capital gains exclusions; and reduced corporate tax rates.

It also added Section 125 to the Internal Revenue Code, which provides the basis for flexible benefit plans commonly known as cafeteria plans, giving participants the ability to avoid taxation on wages which are deferred into the plan. They effectively allow employees to pay for certain benefits on a pretax basis, or receive reimbursement for medical expenses from untaxed dollars.

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Employees--and employers--save taxes on the money they pay toward their group-sponsored health, dental and term life plan premiums, as well as voluntary benefits and dependent care or out-of-pocket medical expenses. The employee has more money to take home--as any dollar deferred into the plan is withheld before taxes are calculated--and the employer saves on federal, state and Social Security taxes on every dollar contributed to the plan.

General types of tax-qualified plans under Section 125:

Cafeteria Plans

WHAT IT IS: These plans must offer a combination of at least one qualified benefit - which is nontaxable - and cash salary--which is taxable. Employees can choose between different types of benefits, similar to how they might select food in a cafeteria.

WHAT IT INCLUDES: In addition to health insurance, cafeteria plans can cover automobile, group term life insurance and business travel accident insurance. Flexible spending accounts and 401(k) contributions also are common.

These are nontaxable benefits, but there also is a choice of taxable benefits. They can include discounted group automobile or homeowners insurance, vacation days or cash. Even though these benefits are taxable, they are still considered benefits, since employees may not have had access to them if not for the plan.

There are no rollover benefits under the cafeteria plan. The participant must forfeit the unused benefits at the end of the year, except for 401(k) contributions.

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VALUE TO EMPLOYEES

* A benefit plan that increases take-home pay; and

* Plans allow employees to select items that fit their lives.

VALUE TO EMPLOYERS

* A reduction on taxable income and, consequently, tax liability. Payroll costs decrease, meaning savings on FICA (Federal Insurance Contributions Act) taxes. The more the employee contributes, the greater the tax advantage. There also may be a savings on workers' compensation tax; and

* An employer can control the company's share of medical costs, without limiting employee choices.

Premium Only Plans (POPs)

WHAT IT IS: Employees pay their group insurance premium contributions with pretax dollars.

WHAT IT INCLUDES: These plans can exist within a cafeteria plan or separately. In addition to health premiums, dental and vision are among premiums that are often designated. The plans also do not discriminate in favor of highly compensated employees.

VALUE TO EMPLOYEES

* Taxes aren't paid on contributions.

VALUE TO EMPLOYERS

* Reduces FICA withholdings.

How Pretax Premiums
Boost Take-Home Pay
                        Without     With
Employee                    POP      POP

Monthly Gross Salary     $2,500   $2,500
Before-Tax Premium            0     $400
Adjusted Gross Salary    $2,500   $2,100
FICA *                     $191     $161
After-Tax Premium          $400        0
Net Income               $1,909   $1,939

* FICA taxes = 7.65% on the dollar; example does not include federal
or state taxes

Flexible Spending Accounts (FSAs)

WHAT IT IS: These accounts are reimbursement arrangements established by employers to allow employees to pay their group health insurance premium contribution with tax-free dollars.

WHAT IT INCLUDES: Much like an expense account, the FSA reimburses employees for health and/or dependent care over the course of a plan year.

Employees decide at the beginning of the plan year how much they want to contribute to their spending account(s). The money is automatically deducted from the paycheck, before taxes are calculated. It can then be used to pay for out-of-pocket health and dependent care costs, including certain expenses that are not covered by other plans, including dental, vision, prescription drugs and some over-the-counter medicines.

Expenses in a Dependent Care FSA may only be claimed for dependents who are under the age of 13; or for older dependents who live with the employee at least eight hours each day and are incapable of self-care.

Expenses include day care, baby-sitting and general purpose day camps. Unlike the Health FSA, reimbursements under the Dependent Care FSA cannot be given for services that have not yet been received.

Money in a FSA cannot be rolled over into the next year. Unused contributions at the end of the plan year are forfeited.

However, employers may allow employees a grace period of up to 21/2 months to use those funds for expenses incurred during the grace period.

VALUE TO EMPLOYEES

* Money put into accounts is tax-free, so taxable income is lower;

* Reduced out-of-pocket expenses;

* Money can be used for expenses not covered by other plans; and

* Full annual election amount available first day of plan year (Health FSAs only).

VALUE TO EMPLOYERS

* Contributions result in savings on FICA, state, and federal unemployment taxes related to employee contributions to the FSA.

DID YOU KNOW?

The Internal Revenue Service has no set limits on Section 125 plans, but Section 129 plans, which allow employees to set aside funds for dependent-care expenses, have an annual $5,000 limit. Section 132 plans allow participants to set aside pretax dollars for certain parking and commuting expenses.