They’ve been called one of the most under-used employee benefits for small businesses. Not only do they allow employees to set aside a portion of their pre-tax salary for qualifying insurance premiums, medical expenses and even child-care expenses, they also reduce employer payroll tax liability by eliminating matching FICA taxes of 7.65 percent and, depending on the state the business is operating in, possibly also workers compensation. What are they? They are Section 125 Cafeteria Plans.
Despite the fact that Section 125, or cafeteria, plans appear to be a win-win proposition, MSNBC reports that only 8 percent of full-time workers choose them, according to the Employee Benefit Research Institute. This is not terribly surprising since Section 125 Cafeteria Plans, named after the Internal Revenue Code Section defining them, have a difficult reputation. Difficult reputation or not, there are signs that cafeteria plans are growing in popularity among businesses of all sizes and their employees.
“As healthcare costs and workers comp rates continue to rise, 125 plans will become more popular with employers,” Leonard Sanicola, senior practice leader at WorldatWork, a nonprofit association for compensation and benefits education, told MSNBC. “2006 will be the year when you see large employers offering these plans in conjunction with traditional plans, with the goal down the road of making 125 plans the only ones offered so that employees become more accountable for their expenses.”
There are two reasons a business, especially a small business, should consider a section 125 plan. According to www.coredocument.com Core Documents, Inc., a provider of Internal Revenue Service(IRS) and Department of Labor (DOL) compliant Plan Documents and Do-It-Yourself Kits for employers, the reasons are:
- Implementing a Section 125 plan can “soften the blow” of increases in premiums on employees, if you also offer traditional healthcare benefits.
- Every dollar run through a Section 125 plan reduces an employer’s payroll. Therefore the employer does not have to pay FICA or workers compensation premiums, depending on the state where the business is located.
The three reasons Core Documents gives for employees to consider a cafeteria plan are:
- Participation in a Section 125 plan reduces the employee’s taxable salary and increases the percentage of their take-home pay.
- The effects of increases in insurance premiums, co-pays, deductibles, etc. are minimized because, through a Health Flexible Savings Account (FSA), employees can set aside funds to cover the increased costs.
- Employees receive a greater deduction on dependent care expenses than is available from the traditional tax credit at the end of the year.
Employees frequently cite the “use it or lose it” aspect of FSAs as the main reason they do not participate in cafeteria plans. The IRS, in May, issued a new rule aimed at mitigating some of that barrier by providing a two-month “grace period” during which unused FSA funds from 2005 can be carried over into 2006 as long as the plan has been amended to allow for such carryover prior to the end of the year. Another means of reducing the risk of losing unused funds at the end of the year is for employees to do better a job of estimating annual healthcare costs at the start of the year. Benefitsnews.com provides these tips for estimating how much should be put aside in an FSA:
- Determine the expenses related to regular visits to doctors, nurses or dentists. Don’t forget eye exams, mammograms, flu shots, and anything else you or family members are likely to do during the coming year.
- Calculate how much you spend on prescription and over the counter drugs that are taken regularly.
- Consider the likelihood of any “extraordinary” expenses. These can be anything from new glasses to braces for junior to that major bout with the flu that seems to hit you every other year. If you want to hedge your bets, take 85 percent of this total to use in your calculations.
- Finally, add it all up. The figure you arrive at should cover 100 percent of guaranteed expenses and at least 85 percent of “extraordinary” expenses in the coming year.
Employers interested in offering cafeteria plans need to be aware of several administrative procedures necessary for compliance with Section 125 code legal requirements. According to Core Documents, these procedures include:
- Establishing a plan document outlining specific details of the plan including descriptions of the employee benefits covered, participation rules, annual limits, election procedures, eligibility, employer contribution (if any) and the plan year.
- Distributing a summary plan description (SPD) to all participants. The SPD summarizes specific plan details, claim filing procedures and information about plan sponsorship and administration.
- Being aware of ongoing compliance issues. Failure to be aware of changing laws and regulations can eliminate the tax-free status of FSAs.
Small businesses interested in establishing a cafeteria plan and administering it themselves can obtain Section 125 plan documents from Core Documents. A variety of modules are available and Section 125 Cafeteria Plan experts are available to discuss your needs and options with you at 1-888-755-3373.
Small businesses wanting more help establishing and administering a Section 125 plan might wish to consider consulting a professional employer organization (PEO).
“This is a tremendous service to small-business owners and a major benefit to workers,” Milan P. Yager, executive vice president of the National Association of Professional Employer Organizations (NAPEO) said in a prepared statement about cafeteria plans. “The PEO’s cafeteria plan gives small businesses and their employees a big business benefit and may encourage employees to seek the care they need when they need it.”