26 Feb The Ultimate FAQ Guide to Section 125 Plans | Employer & Employee Answers
Section 125 Plans: Answering Your Top Questions
Section 125 plans, also known as “cafeteria plans,” offer tax-saving benefits for both employers and employees. But how do they work? Who qualifies? And what are the IRS rules you need to know?
We’ve compiled this comprehensive FAQ guide to address the most common search queries about Section 125 plans. Whether you’re an employer looking to implement a plan or an employee wondering how it affects your paycheck, we’ve got you covered.
Need expert guidance? The Policy Shop is here to help you set up and optimize your Section 125 plan.
What Is a Section 125 Plan?
A Section 125 plan allows employees to pay for eligible benefits—such as health insurance, dental, vision, and flexible spending accounts (FSAs)—using pre-tax dollars. This reduces taxable income for employees and payroll tax liability for employers.
Key Benefits of a Section 125 Plan:
✔ Employees pay less in taxes and take home more money
✔ Employers save on payroll taxes (Social Security & Medicare)
✔ Helps businesses stay competitive in hiring and retain employees
📞 Want to set one up? Contact The Policy Shop to get started!
Who Is Eligible for a Section 125 Plan?
For Employees:
- Most full-time employees qualify
- Must be offered by their employer
- Participation is voluntary
For Employers:
- Available to businesses of all sizes
- Sole proprietors, partners, and S-corp owners may not be eligible for pre-tax benefits under IRS rules
💡 Pro Tip: Need help determining if your business qualifies? Talk to The Policy Shop today!
What Types of Benefits Can Be Included in a Section 125 Plan?
A Section 125 plan can include:
✅ Health insurance premiums (medical, dental, vision)
✅ Flexible Spending Accounts (FSAs)
✅ Health Savings Accounts (HSAs) (if paired with a high-deductible health plan)
✅ Dependent Care Assistance Programs (DCAPs)
✅ Group-term life insurance (up to $50,000 coverage)
❌ What’s NOT Allowed?
- Employer contributions to retirement plans
- Fringe benefits like tuition assistance or transportation subsidies
📢 Not sure what benefits to offer? The Policy Shop can help customize the right plan for your business!
How Much Can Employees Save with a Section 125 Plan?
The tax savings add up fast! Here’s an example:
🔹 Employee Salary: $50,000
🔹 Pre-Tax Health Insurance Deduction: $5,000
🔹 Tax Savings: ~$1,200/year (based on a 24% tax bracket)
💰 It’s like getting a raise—without increasing salaries!
👉 Employers also save around $382.50 per employee in payroll taxes (FICA, FUTA). Multiply that across multiple employees, and your business can save thousands per year!
📞 Contact The Policy Shop to calculate your company’s potential savings.
What Are the IRS Compliance Rules for Section 125 Plans?
To remain IRS-compliant, employers must:
✔ Have a written plan document outlining benefits and eligibility
✔ Follow nondiscrimination rules (can’t favor highly compensated employees)
✔ Allow changes only during open enrollment or qualifying life events
💡 Failure to comply can result in back taxes and penalties!
Need help ensuring compliance? The Policy Shop specializes in IRS-compliant Section 125 plans for businesses.
Can Employees Change Their Section 125 Elections?
Changes are only allowed during:
🔹 Annual open enrollment
🔹 Qualifying life events, such as:
- Marriage or divorce
- Birth or adoption of a child
- Job loss or new job affecting benefits
📢 Employees should choose wisely! Once enrolled, changes cannot be made unless a qualifying event occurs.
Need to educate your employees? The Policy Shop can help!
How Do Employers Set Up a Section 125 Plan?
Step-by-Step Process:
1️⃣ Create a plan document (outlining benefits, eligibility, and rules)
2️⃣ Select benefits (health insurance, FSAs, dependent care, etc.)
3️⃣ Set up payroll deductions (ensure pre-tax processing)
4️⃣ Communicate with employees (so they understand their options)
5️⃣ Ensure IRS compliance (nondiscrimination testing, record-keeping)
💼 Want an easy setup? The Policy Shop provides turnkey solutions for Section 125 plans—contact us today!
Are There Any Downsides to a Section 125 Plan?
While the tax savings make a Section 125 plan highly attractive, there are a few considerations:
❌ Use-It-or-Lose-It Rule: Some FSAs have restrictions on unused funds.
❌ Lower Social Security Benefits: Because taxable wages decrease, future Social Security benefits may be slightly reduced.
❌ Plan Administration: Employers must stay compliant with IRS regulations.
📢 The benefits far outweigh the drawbacks! Need help with compliance? Let The Policy Shop handle it for you.
What Happens If an Employer Doesn’t Offer a Section 125 Plan?
Employers without a Section 125 plan face:
🔹 Higher payroll taxes (more money paid to the IRS)
🔹 Lower employee retention (workers prefer pre-tax benefits)
🔹 Decreased competitiveness in hiring top talent
💡 Not offering one is costing your business more than you think!
📞 Get in touch with The Policy Shop today to start saving on taxes and improving your benefits package.
Final Thoughts: Section 125 Plans Are a Win-Win for Employers & Employees
A Section 125 plan is a powerful tool that reduces taxes, boosts employee satisfaction, and saves businesses money. Whether you’re an employer looking to implement a plan or an employee wanting to maximize your paycheck, understanding how these plans work is key.
🚀 The Policy Shop makes it easy to set up and manage a Section 125 plan that fits your business’s needs.
📢 Ready to save money and improve your benefits package? Contact The Policy Shop today!