Crafting an employee benefits package that meets the unique needs of every employee can be challenging. Cafeteria-style benefits can appeal to a variety of workers with flexible options. But, what exactly is a cafeteria plan and how could you leverage this employee benefit to help your organization achieve its goals?
What is a cafeteria plan?
Cafeteria plans are sometimes called flexible benefit plans (because they provide greater flexibility) or Section 125 plans (because they’re allowed under and governed by Section 125 of the Internal Revenue Code).
In a cafeteria-style restaurant, there are many food options available, meaning you can pick and choose your perfect meal. However, a cafeteria isn’t a buffet. Since you have to pay for each item you select, you don’t want to pile up your plate with food you don’t need. To keep costs reasonable, you need to be selective with the foods you choose.
A cafeteria plan for health insurance has a similar premise. Under IRS rules, plan participants select the benefits they want to receive. The employer agrees to contribute a certain amount, and the employee makes contributions to cover the remainder.
Employees typically make contributions under salary reduction agreements that allow them to contribute a portion of their salary on a pre-tax basis. Participants must elect the salary reduction amount and benefits prior to the beginning of the coverage period. See the IRS Introduction to Cafeteria Plans for more details.
Health Insurance and Other Benefit Options
Under IRS regulations, all cafeteria plans must also offer a cash option. In a premium-only plan, employees can elect to take their full salary in cash or to use the benefit to pay for group health insurance premiums.
The types of benefits that can be run pre-tax through a cafeteria plan include:
- Group health insurance
- Flexible Spending Accounts (FSAs)
- Health Savings Accounts (HSAs)
- Dependent Care Assistance Plans (DCAPs)
- Dental insurance
- Vision insurance
Flexible Spending Accounts and Health Savings Accounts
Employers can offer Flexible Spending Accounts (FSAs) as part of a cafeteria plan. This gives eligible employees even greater flexibility for how they use their benefits.
A Flexible Spending Account is an employer-sponsored and employer-owned account that employees can use to pay for eligible health-related expenses using pre-tax dollars. Although they cannot use FSAs to pay for insurance premiums, employees can use them for a wide range of other health-related costs, such as health insurance deductibles, copays, prescription drugs, medical equipment and over-the-counter medications.
Employers can also offer Health Savings Accounts (HSAs) as part of a cafeteria plan. HSAs are tax-advantaged accounts that help individuals who have high-deductible health plans to cover health-related costs. Employees may even be able to use these accounts in retirement because the funds do not expire and are available tax-free, as long as participants follow certain rules.
While both FSAs and HSAs can help employees pay for qualified medical expenses using pre-tax contributions and can both be offered by employers in a cafeteria plan, the similarities end there.
HSA eligibility hinges on enrollment in a high-deductible health plan, while eligibility for an FSA is dependent on the employer’s benefit offerings. FSAs are owned by the employer and the funds operate on a “use it or lose it” basis (although some funds may roll over to the following year). HSAs are owned by the individual, so the funds do not expire and the account is portable during job changes.
It’s important for employers to note that employees cannot enroll in both an HSA and FSA. Because of this, many employers decide to offer either HSAs or FSAs – or to offer a limited FSA alongside an HSA.
The Appeal of Cafeteria Benefit Offerings
Cafeteria benefit plans are popular for two key reasons: their flexibility and potential tax advantages.
Cafeteria Benefits Offer Flexibility
Today’s workforce is diverse, with multiple generations working side-by-side. A Baby Boomer preparing for retirement, a Millennial starting a family and a Gen Zer entering the workforce will all have different benefit needs.
A cafeteria plan puts workers in control of their benefits and empowers them to select the benefit options that make sense for their situations. This is good for the workers, but it’s also good for the employers because increased employee satisfaction can lead to improved employee engagement and retention.
Cafeteria Benefits Could Provide Tax Advantages
Employees can choose to purchase benefits with pre-tax payroll deductions, which decreases the amount they owe in income, Medicare and Social Security taxes. With many workers struggling financially due to inflation, it’s important to ensure their paychecks go as far as possible. Employers can also receive tax advantages because a cafeteria arrangement decreases the amount of Federal Insurance Contributions Act (FICA) taxes owed.
Offering Cafeteria Plan Benefits
Before offering a cafeteria plan, employers should consider both the pros and cons. We’ve already looked at the advantages, so let’s consider some potential drawbacks:
- Employees may be unable to change their minds mid-year. Under IRS rules, participants cannot revoke their cafeteria plan benefit elections during the coverage period, unless this is due to an event that triggers a special enrollment period under HIPAA or a qualified life change event. Plans must also allow participants who are taking unpaid FMLA leave to revoke an election for health plan coverage.
- Contributions may be subject to limits. FSAs and DCAPs offered as part of a cafeteria plan are subject to contribution limits set by the IRS. While HSAs also have contribution limits, unlike DCAPs and FSAs, employees are the ones responsible for ensuring they do not exceed these limits.
- Cafeteria plans require careful oversight. Flexibility is an advantage for meeting the needs of a diverse workforce, but it results in additional benefit plan administration responsibilities, such as ensuring that employees do not make both FSA and HSA contributions or make midyear changes without a qualifying event. Before adopting a cafeteria benefit plan, employers should ensure they have the resources necessary to do so successfully and compliantly. If employers don’t have the internal resources needed, their employee benefits broker may offer benefits administration services.
Is a cafeteria plan right for your company?
Higginbotham can help you pursue a cafeteria plan for your employee benefits. We offer employee benefit packages designed to maximize employee satisfaction while minimizing costs – and then support your HR team and employees throughout the year with services like FSA and HSA administration. Talk to one of our employee benefits specialists to learn more.
