What Is a Cafeteria Plan?

A cafeteria plan is an employee benefit plan that allows staff to choose from a variety of pre-tax benefits, helping to reduce taxable income. Employees can contribute a portion of 💜their gross income before taxes are deducted, giving them the flexibility to select benefits that suit their personal 🐻needs.

These plans typically include options like insurance benefits, retirement contributions, and support for life events such as adoption. Cafeteria plans are also known as flexible benefits plans or Section 125 plans, referencing the section of the 澳洲幸运5官方开奖结果体彩网:Internal Revenue Code that governs them.

How Cafeteria Plans Work

A cafeteria plan gets its name from the concept of a cafeteria, where individuals can choose from a variety of food options. In the same way, employees can select from a menu of benefits before 澳洲幸运5官方开奖结果体彩网:payroll taxes are calculated.

Common cafeteria plan options include:

• 澳洲幸运5官方开奖结果体彩网:Health Savings Accounts (HSAs)
• Group term life insurance
• 澳洲幸运5官方开奖结果体彩网:Disability insurance
• Adoption assistance plans
• 澳洲幸运5官方开奖结果体彩网:Flexible spending accounts (FSAs)
• Cash benefits

Flexible plan selections allow employees to tailor a cafeteria plan to their specific needs. For example, an employee approaching retirement may prioritize contributions to their 401(k), while someone with a large family might choose a more comprehensive health in♔surance pl๊an.

Section 125 of the Internal Revenue Code (IRC) specifies that cafeteria plans are exempt from the calculation of gross income for federal income tax purposes. No federal or 澳洲幸运5官方开奖结果体彩网:Social Security taxes are deducted. However, some benefits, such as group life insurance benefits that exceed $50,000 or adoption assistance benefits, require employers to withhold both 澳洲幸运5官方开奖结果体彩网:Social Security and Medicare taxes.

Special Considerations

Employees must estimate how much money they are going to contribute to their cafeteria plan before the tax year begins. The elected amount of money is divided by the number of payroll periods and deducted from each paycheck for the duration of the plan.

It’s important to note that any funds allocated but not used by the end of the year are forfeited, a rule known as the "use it or lose it" policy. However, changes have been made to allow employees to roll over up to $500 of unused funds into the next year.

The complex and individualized nature of c🐈afeteria plans makes them more time-consuming and costly to administer than other benefits plans. Employers must maintain continuous communication with employees to ensure they are aware of any changes to benefits, costs, or coverage.

Employees' changing circumstances may result in continual administration. This can partly be rectified by only allowing benefits to be changed periodically. For example, your company may only allow you tꦛo change your cafeteria plan benefits once a year.

Advantages and Disadvantages of Cafeteria Plans

Advantages

One of the main benefits of a cafeteria plan is the fact that it lowers your tax liability. By making 澳洲幸运5官方开奖结果体彩网:pre-tax contributions to the plan, you reduce your 澳洲幸运5官方开奖结果体彩网:gross income. Payroll taxes are deducted based on gross income, so the lower it is, the less tax you pay.

Employers can choose from both nontaxable and taxable benefits under cafeteria plans. Benefits such as insurance options and 澳洲幸运5官方开奖结果体彩网:retirement contributions are considered nontaxable options. These allow the employee to contribute to these plans without incurring any tax penalties—a major benefit and advantage for an employee's 澳洲幸运5官方开奖结果体彩网:bottom line.

Disadvantages

There are drawbacks to cafeteria plans. According to the IRS, plan holders "must be permitted to choose among at least one taxable benefit (such as cash) and one qualified benefit." This means that the taxable benefit will trigger a tax liability for the tax year on the amount of the taxable benefit received.

Another drawback to cafeteria plans is their complexity. Because plans are not standard from employee to employee, they can take a lot of time to maintain and a▨dminister. This can increase costs for employers.

Employees who excee⭕d their allocated spending amount pay a partial premium to their employer. So if Emma spends $1,000 over her allocated cont♏ribution, she pays a portion of that amount herself.

Cafeteria Plans🍎 and Flexible Spending Accounts (FS🐓As)

The rules for a flexible spending account (FSA) differ slightly from the "use it or lose it" rules that apply to other cafeteria plan benefits. Employers are allowed to establish a grace period for their FSA, or extra time beyond the end of the year. This allows you to spend the money from your FSA so you don't lose the funds. Alternatively, employers can offer unused contributions to carry over into the following year's plan.

Cafeteria plans must also establish a limit for the size of contributions that you can make to an FSA that is part of a cafeteria plan. If there is no limit, the FSA isn't considered part of a cafeteria plan, and all the benefits included in the plan are considered part of your taxable income. In 2025, this limit is $3,300.

The Bottom Line

Cafeteria plans provide employees with a flexible range of pre-tax benefits, including options such as retirement plans, life insurance, and health savings accounts. Employees can customize their benefits package to suit their personal aꦦnd family needs while enjoying the advantage of reduced tax liability.

However, cafeteria plans can be complex to administer and may come with forfeiture rules if unused funds are not spent by the end of the ye♉ar. Despite these challenges, cafeteria plans remain a valuable option for both employees and employers seeking flexibil﷽ity in benefit offerings.