05 Mar How a Section 125 Plan Can Increase Your Take-Home Pay
Section 125 Plan: How Much Can You Save?
A Section 125 plan, also known as a cafeteria plan, is a powerful tool that allows employees to save money on taxes while receiving valuable benefits. But how exactly does it work? And more importantly, how much can you actually save? Let’s break it down with examples to show the financial advantages.
How Does a Section 125 Plan Work?
A Section 125 plan allows employees to pay for certain benefits—such as health insurance, vision and dental plans, and flexible spending accounts (FSAs)—with pre-tax dollars. This means that the money is deducted from your paycheck before taxes are applied, reducing your taxable income and, ultimately, increasing your take-home pay.
Employers also benefit from Section 125 plans because they reduce payroll taxes, making them a win-win for businesses and employees alike.
How Much Can You Save? Real-World Examples
Let’s say an employee earns $50,000 per year and is enrolled in a Section 125 plan that includes health insurance and an FSA. Here’s how the savings add up:
Example 1: Without a Section 125 Plan
- Gross Pay: $50,000
- Taxable Income: $50,000
- Federal & State Taxes (22% estimate): -$11,000
- Net Pay After Taxes: $39,000
- Healthcare Premiums (Post-Tax): -$3,000
- Take-Home Pay: $36,000
Example 2: With a Section 125 Plan
- Gross Pay: $50,000
- Pre-Tax Deductions for Health Insurance & FSA: -$5,000
- New Taxable Income: $45,000
- Federal & State Taxes (22% estimate): -$9,900
- Take-Home Pay After Pre-Tax Savings: $40,100
Total Savings: $4,100 more in take-home pay per year!
These savings can be even greater for employees with higher incomes or additional pre-tax benefits like dependent care FSAs.
Why Employers Should Offer a Section 125 Plan
Employers who implement a Section 125 plan can benefit in several ways:
- Lower payroll taxes: Since pre-tax contributions reduce taxable wages, employers save on payroll taxes (FICA, FUTA, etc.).
- More attractive benefits package: Offering tax-saving benefits helps attract and retain top talent.
- Cost-efficient solution: Compared to increasing salaries, offering a Section 125 plan is a budget-friendly way to boost employee compensation.
How to Enroll in a Section 125 Plan
If your employer offers a Section 125 plan, you can typically enroll during open enrollment or after a qualifying life event (such as marriage or having a child). Ask your HR department about your options or contact The Policy Shop for guidance on implementing a Section 125 plan for your business.