Cafeteria Plan: What Is It and Why Should We Care

What is a cafeteria plan?

A cafeteria plan is an employee benefit plan offered in the US which follows Section 125 of the tax code. Its name is derived from earlier plans that enabled employees to pick and choose between different types of benefits offered by an employer, as they would pick and choose among food choices in a cafeteria.

In 2005 the federal government announced that employers could design “cafeteria” plans that would reimburse claims for participants that were incurred up to 2½ months after the end of the year.  Before this, reimbursements were only valid for claims during the plan year. But with this new ruling,  a grace period was extended until March 15 to the employee participating in a Flexible Spending Account or FSA plan ending December 31 provided that the grace period was adopted by the employer. This new expansion of the claims reimbursement cycle reduced the  “use it or lose it” fear among many employees  and as a result increased the overall number of employees choosing to participate in an FSA. At the same time, employees were better able to target the funds for purchases that they actually needed.

Cafeteria plan benefits include:

• Accident and health benefits (but not Archer medical savings accounts or long-term care insurance)
• Adoption assistance
• Dependent care assistance
• Group-term life insurance coverage
• Health savings accounts (HSA insurance plans), including distributions to pay long-term care services

A section 125 plan is the only means by which an employer can offer employees a choice between taxable and nontaxable benefits without the choice causing the benefits to become taxable. A plan offering only a choice between taxable benefits is not a section 125 plan.

Why should we care?

Employees who have access to a cafeteria plan frequently obtain benefits such as health insurance, group-term life insurance, and flexible spending accounts through the plan.  Most of these plans are offered through a  “salary reduction agreement”, which is basically a payroll deductions.  These deductions are pre-tax deductions, not considered income and are not taxed for federal income tax purposes.

Reasons for implementing a cafeteria plan? The biggest reason is the tax advantages to the employer and employee. Both parties save on taxes and as a result increase their spendable income.

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