What is a cafeteria plan?

A cafeteria plan is an employer-sponsored benefit that meets the requirements of section 125 of the Internal Revenue Code (IRC). The most distinct aspect of a cafeteria plan is that it permits employees to pay for specific benefits on a pretax basis.

More about what a cafeteria plan is and its purpose

Employees who opt for a cafeteria plan must be allowed to choose at least one taxable benefit (for example, cash in the form of salary) and one qualified benefit, such as group health insurance.

To qualify, the benefit cannot defer compensation, meaning it cannot be paid at a later date. Additionally, contributions for the benefit are generally excluded from the employee’s gross income. This means the employer does not withhold certain taxes from the employee’s payment/contribution for the benefit. These taxes would have applied had it not been for the cafeteria plan.

The origin and purpose of cafeteria plans

The Revenue Act of 1978 formally incorporated section 125 into the IRC. While cafeteria plans were available prior to 1978, employees had to pay taxes on employer contributions. The Revenue Act of 1978 resolves this by making both employer and employee contributions nontaxable, provided the amounts stay within the prescribed legal limits. Ultimately, cafeteria plans deliver tax savings to both employees and employers.

Types of benefits offered under a cafeteria plan

Qualified benefits include:

A cafeteria plan excludes benefits not regulated by Section 125 of the IRC, including educational assistance, commuter benefits, and health reimbursement arrangements.

Types of benefits offered under a cafeteria plan

Qualified benefits include:

A cafeteria plan excludes benefits not regulated by Section 125 of the IRC, including educational assistance, commuter benefits, and health reimbursement arrangements.

What employers should know about cafeteria plans

Pros and cons of cafeteria plans

Cafeteria plan laws to keep in mind

As mentioned, plan sponsors must comply with IRC Section 125. Other laws affecting cafeteria plans include the following:

Additionally, employers should consider applicable state and local laws, including those pertaining to nondiscrimination and wages and hours.

Communicating cafeteria plans to employees

In a 2023 MetLife survey, 50% of employees “say having a better understanding of their benefits would make them more loyal to their employer.”

Therefore, it’s important that employees understand the benefits available to them. Otherwise, it can lead to underutilization of the benefits, resulting in financial waste for the employer. What’s more, employees may lose out if they don’t know about the program or how to properly navigate it.

To prevent these outcomes, employers should clearly communicate the cafeteria plan program to their employees. Below are aspects to cover:

Using cafeteria plan in a sentence

“Joining my employer’s cafeteria plan puts more money in my pocket because I don’t pay taxes on my contributions.”

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