Making Sense of Section 125, Cafeteria Plans, and HSAs
It’s important to understand the differences between employee benefit offerings, so you can choose a combination that helps your people save money while strengthening their loyalty to your business. To help you avoid confusion, here are some quick explanations of some commonly misunderstood tax-saving benefits.
Section 125 Plans
Premium Only Plans (POP) and Flexible Spending Account (FSA) medical and dependent-care benefits are often referred to as section 125 plans, as they are each described in section 125 of the Internal Revenue Code (dependent care under Section 129).
With this plan, employee participants may have their healthcare premium payments deducted from their paychecks before taxes are deducted, which in effect reduces the amount of income used for tax calculations. A POP may be only be offered by an employer with a group medical plan.
Also offered solely in conjunction with a group medical plan, FSA benefits help employees budget for predictable out-of-pocket medical and dependent care expenses, such as daycare or elder care. Consider how much an employee's household might spend in a year on expenses such as maintenance medications (medication taken daily or weekly), yearly eye care expenses, routine or special-need dental work, and weekly or summer daycare costs. Pretax deductions will be used to fund these expenses and can lead to significant amounts saved per quarter and per year.
As with food service, a cafeteria plan allows employees to pick benefits from a menu of offerings. Any costs beyond the maximum your company will pay then become the responsibility of the employees, paid for via payroll deductions throughout the year. Together with POPs and FSAs, as well as non-section 125 plans such as an Adoption Assistance Plan, cafeteria plans allow pretax deductions, which may help employees pay less in taxes.
Health Savings Account (HSA)
An employee’s eligibility for an HSA depends on his or her use of a high deductible health plan. Participants have a chosen amount within limits outlined by the Internal Revenue Service deducted from their paychecks on a pretax basis to be spent on certain medical needs. The additional benefit of an HSA is that any funds that remain unused at the end of the year “roll over” into the next, whereas FSA funds are lost at the close of the plan year.
If you decide your business will offer a section 125 plan, cafeteria plan, or HSA to its employees, you’ll need to include the plan(s) as part of your annual enrollment period, so that eligible employees may sign up, maximize the usage of your new benefits, and potentially save money on taxes.