A Section 125 Plan is an employer-provided benefit where the employee can choose from a range of different benefits and pay for them with pre-tax dollars. Section 125 refers to the Internal Revenue Code section that governs the administration of these plans. Another term for a Section 125 Plan is the "Cafeteria Plan" plan owing to its inherent feature that allows employees to make his selection from different benefit options, much as one would do in a cafeteria.

There is a wide range of benefits available to employees through the Section 125 Plan. Typical benefits include health, life, and dental plans but other cafeteria plans may also cover disability insurance, cancer insurance, eye care, and appropriation for Health Savings Accounts.

The IRS Code also specifies which employees can or cannot participate in a Section 125 Cafeteria Plan. Sole proprietors and 2% shareholders of S Corporations can't for example. The employer should also take pains to make sure that the 125 Cafeteria plan does not discriminate in favor of "highly compensated" or "key" employees. Both of these terms are extensively defined by the IRS, but essentially a plan can't provide the lion's share of benefits to officers or owner-employees without facing adverse tax consequences.

Why bother having a 125 Cafeteria plan? The resulting tax savings is one of the biggest advantages. Cafeteria plans allow employees to pay for benefits on a pre-tax basis. That is, the premium is deducted from the employee's taxable income, thereby reducing his Federal withholding, FICA tax, and Medicare tax. It's like a pay raise that didn't cost the employer a thing. Depending on the state where you're located, state taxes might be lowered as well.

The sponsoring employers also get to benefit from reduced taxes because the decrease in an employee's taxable income would also mean a reduction in the matching employer share of FICA and Medicare taxes as well as FUTA taxes. Another advantage that comes from sponsoring a Section 125 Cafeteria Plan to employees is that the employer can offer a mishmash of benefits for his employees to just choose which they need most; these are benefits which most employer could ill-afford if not for Section 125. With the contributions deducted on a pre-tax basis, the employees can "afford" to avail of the benefits on their own using their tax savings.

The biggest downside of Section 125 Cafeteria plans are the administrative requirements. First, you need a Plan Document, which, aside from the initial preparation needs to be kept updated to keep up with IRS regulations. Some companies have legal and tax professional consultants just to keep Section 125 documents in compliance. There is also a cost involved; the National Conference of State Legislatures estimates that an employer will pay up to $100 per employee to set up and administer a Section 125 Cafeteria Plan; the tax savings, however, can easily cover this cost.

A Section 125 Plan can be a great tool to expand your employees' benefit options while also benefiting your company.

Check out our site to know more about a Section 125 Plan, specifically the Premium Only Plan (POP). If you've already got an existing plan, then you can learn more about our automatic document solution that can provide prompt and cost-effective updates to your Section 125 Plan Document.