Cafeteria plans, also described as "flexible benefit" plans or Section 125 plans, allow participating employees to choose between a number of non-taxable qualified benefits or taxable cash. Plans typically offer participants a "cafeteria menu" of items, including group term life insurance, medical expense insurance, dependent group term life insurance, child care, and dental expense coverage.
Among the advantages to an employer that establishes such a plan are reductions in FICA (Federal Insurance Contributions Act) and FUTA (Federal Unemployment Tax Act) taxes, expansion of employee benefits, and enhanced employee appreciation of the benefit package.
Employee advantages include the opportunity: (1) to select benefits most suited to individual needs; (2) to pay for these benefits with before-tax rather than after-tax dollars; (3) to obtain benefits that may not be available for individual purchase; and (4) to pay less FICA taxes by reducing taxable income.
The design of cafeteria plans can range from simple "premium only" plans to full-blown flexible benefit plans including flexible spending accounts. Premium-only plans, which are also referred to as "premium-conversion" plans, merely allow employees to use their before-tax, rather than after-tax, dollars for plan contributions. In contrast, flexible spending accounts allow employees to defer before-tax dollars to pay for dependent care expenses and unreimbursed medical expenses (such as deductibles and coinsurance payments, glasses, and eye exams).
The election to defer dollars must be made in advance of the plan year and can be changed only under limited circumstances. With flexible spending accounts, employees forfeit fund balances that are not used up by the end of the plan year, except for a 21/2 month grace period if permitted by the plan (regarding a one-time opportunity to make a rollover contribution from a health flexible spending account to a health savings account, see footnote 4, page 269). An additional period is allowed after the close of the plan year for submission of claims incurred during the plan year. Forfeitures may be used to offset the employer's cost of administering the plan, reallocated proportionately to other employees, or given to charity.
Former employees may participate, but self-employed individuals may not. All plans are subject to special nondiscrimination rules. Proper administration of cafeteria plans requires preparing plan documents, conducting annual enrollments, tracking claims and benefit payments, and filing yearly 5500 reports.
See also, Consumer-Directed Health Plans, page 387, and Defined Contribution Health Plan, page 402.