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How to Know if a Section 125 Plan Is Right for Your Business

Employee Benefits

In a section 125 plan, employees are able to use a portion of their pre-tax income to fund accounts for specific needs, including health care, childcare, or dependent care costs. This type of plan provides the individual with a way to save money for when it’s needed while also allowing the business to benefit from reduced expenses. However, before selecting a section 125 plan, you should be aware of a few key pros and cons related to these tax-saving plans.

Pros of Section 125 Plans

Consider some of the benefits of section 125 plans:

  • Saves employees on federal, and most state and local withholding taxes while helping them pay for eligible out-of-pocket expenses.
  • For the business owner, a section 125 plan helps to reduce payroll and tax liabilities, including FICA and FUTA..
  • It helps to lower taxable income. Since funds are placed into this account pre-tax, it reduces the amount of taxable income present on a W-2 later in the year.

These benefits can help to offset the initial plan setup fee and even help the company to save substantially in the long term.

Cons of Section 125 Plans

Consider these drawbacks of a section 125 Plan before electing to use them.

  • Those people who put funds into a section 125 plan called a health flexible spending account must use those funds during the plan year. If the funds are not used, the participant will lose them. Proper planning is essential from an employee standpoint.
  • Employees are reimbursed for expenses as part of a health flexible spending account. This means expenses must be paid out of pocket first and then are reimbursed after a claim is made.
  • For the employer an initial setup fee is present. Again, this fee is minimized as a result of the significant savings present over the long term.

These drawbacks may not be as problematic as overpaying for other payroll services. It is a good idea to speak to your tax accountant about how section 125 plans could impact your business directly.

When Are These Plans Right for Your Business?

Only you can decide when it makes sense to offer a section 125 plan for your employees. However, there are some benefits to offering this option over others. Your employees may want the flexibility of using these accounts so they can better control their tax liabilities. Additionally, if you want to defray some of the costs associated with managing other plans, this plan can work well. To discover other options when helping employees pay for health care, please download this free whitepaper.

This website contains articles posted for informational and educational value. Paychex is not responsible for information contained within any of these materials. Any opinions expressed within materials are not necessarily the opinion of, or supported by, Paychex. The information in these materials should not be considered legal or accounting advice, and it should not substitute for legal, accounting, and other professional advice where the facts and circumstances warrant.
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