ISSUED 2/20/19
Section 125 – Cafeteria Plans
A section 125 plan, often referred to as a cafeteria plan or POP plan, provides a means for employers to create a tax savings arrangement for their employees to pay for certain benefits on a pre-tax basis. This arrangement increases the employee’s take-home pay, reduces the employee’s taxable income, and therefore, also reduces the employer’s tax liability. Section 125 plans must comply with certain rules and regulations under the Internal Revenue Code.
Section 125 Legal Requirements
A Section 125 plan is the most popular means by which an employer can offer employees a choice between taxable and nontaxable benefits without causing adverse tax consequences to the employees. To avoid benefit taxation, the Section 125 plan must meet the specific requirements of Code Section 125 and underlying IRS regulations, including:
• Maintain a written plan document on or before the first day of the plan year;
• Only common-law employees may participate on a pre-tax basis;
• Elections are generally irrevocable for the entire plan year; with exceptions for change in status events
• Plan must pass certain nondiscrimination tests to ensure it does not favor highly compensated employees.
Types of Section 125 Plans
Premium Only Plan (POP)
• Allows employees to pay their portion of premiums for qualified benefits with pre-tax dollars.
• Also offers cash-out options for employees who decline insurance coverage.
Flexible Spending Arrangement
• Allows employees to purchase benefits under a flexible spending arrangement (health FSA, DCAP, or both) on a pre-tax basis.
• May also incorporate premium payments or just use for flexible spending arrangement.
Full Cafeteria Plan
• Employers make contributions for employees to spend on benefits offered within the cafeteria plan.
• Employee may also contribute pre-tax dollars to purchase additional benefits beyond their purchase with the employer contribution.
Simple Cafeteria Plan
• Plan for eligible small employers (100 or fewer employees).
• Must meet certain contribution, eligibility, and participation requirements.
Examples of Qualified Benefits
Employees must be able to choose between at least one taxable benefit and one or more qualified benefits under a Section 125 plan. Employers may also make nontaxable contributions to a Section 125 plan for their employees. The most common qualified benefits offered to employees are:
• Group health plan coverage
• Dental and Vision plans
• Health Flexible Spending Account (FSA)
• Health Reimbursement Arrangement (HRA)
• Health Savings Account (HSA)
• Dependent Care Assistance Programs (DCAP)
• Adoption Assistance
• Life and Disability coverage
• Accidental Death and Dismemberment (AD&D) coverage