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