Section 125: The Cafeteria Plan

In order to offer pre-tax benefits like health insurance, HSAs and FSAs, you must have what’s called a Section 125 Cafeteria Plan. If you’re not familiar, a Section 125 Cafeteria Plan is a written document maintained by an employer that explains the benefits it is making available to the employee, their spouse and dependents via a salary reduction. The employer makes contributions to the accounts or pays the premiums via a salary reduction and thus said contributions or premium payments are not subject to income tax.

Benefits included in cafeteria plans may include (but are not limited to):

  • Health insurance and accident benefits
  • Adoption assistance
  • Dependent care assistance
  • HSAs
  • FSAs

Do you need a Section 125 Plan?

You can make post-tax contributions to HSAs and FSAs without a Section 125 plan, but if you want to offer benefits on a pre-tax basis, then yes, you will need to implement one. Additionally, you can offer health benefits by implementing an ICHRA or QSEHRA which helps employees pay for insurance premiums without a Section 125 plan in place.

How do you implement a Section 125 Plan?

To start a Section 125 Plan, draft a document outlining the benefits offered, the contribution limits, participation rules and other IRS required information. You might also have to conduct annual non-discrimination testing. If your company doesn’t have in-house expertise in this area, you can always hire a 3rd party administrator.

Businesses with 100 employees or less can receive a safe-harbor from non-discrimination testing if they make the same benefit contributions to each eligible employee.

Who can participate in Section 125 Plans?

Any eligible employee can participate in a Section 125 plan. The following people are excluded from participation:

  • Self-employed
  • Partners in a partnership
  • Shareholders owning more than 2% of a subchapter of an S-corp
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