Section 125

Running a business comes with plenty of responsibilities—one of the most important being offering employee benefits. But did you know that a Section 125 plan could not only enhance your benefits package but also save both your business and your employees money? (Understanding Section 125 Plans)

Section 125, also known as a “cafeteria plan,” is a tax-advantageous benefit that allows employees to choose from a variety of pre-tax benefits. If you’re a business owner looking to improve your employee benefits and reduce your taxable income, understanding how this plan works is crucial.

In this guide, we’ll dive deep into Section 125 plans—explaining the key features, benefits, and how your business can implement one efficiently.

What is a Section 125 Plan?

Defining a Section 125 Plan

A Section 125 plan, named after the IRS code that governs it, is a flexible benefits package that gives employees the option to choose from a range of pre-tax benefits. These benefits can include things like:

• Health insurance premiums

• Dental and vision care

• Flexible spending accounts (FSAs)

• Dependent care assistance

The best part? By offering these benefits pre-tax, both employees and employers can save money on federal income taxes and FICA (Social Security and Medicare) taxes.

How Does a Section 125 Plan Work?

Under a Section 125 plan, employees can choose which benefits they want and how they want to pay for them. They then pay for those benefits with pre-tax dollars, which lowers their taxable income. This means:

• Employees pay less in income taxes.

• Employers save on payroll taxes because employees’ wages are reduced by the amount they contribute to the plan.

It’s a win-win for both parties!

Benefits of Implementing a Section 125 Plan

1. Tax Savings for Employers and Employees

The primary benefit of a Section 125 plan is the tax savings. Both employees and employers get tax breaks:

• Employees reduce their taxable income, meaning they pay lower federal income taxes and FICA taxes.

• Employers reduce their payroll taxes because the total taxable payroll is lowered.

2. Increased Employee Satisfaction

Offering a cafeteria plan | Section 125 Plan with pre-tax benefits gives employees more control over their compensation package. Instead of offering one-size-fits-all benefits, employees can choose what works best for them.

3. Lower Benefit Costs

By leveraging pre-tax deductions, companies can reduce their overall benefit costs while offering competitive, customized benefits. Employees also benefit from having their benefits deducted directly from their paycheck before taxes, maximizing their disposable income.

4. Flexible Spending Accounts (FSAs)

Flexible spending accounts are a key feature of many Section 125 plans. FSAs allow employees to set aside pre-tax money for things like:

• Healthcare expenses (co-pays, prescription drugs)

• Dependent care costs (childcare, eldercare)

These funds help employees manage out-of-pocket expenses for these essential services, and the pre-tax contribution reduces their taxable income.

Key Types of Benefits Offered Through Section 125 Plans

There are several options businesses can include in a Section 125 plan to offer employees more flexibility and better benefits.

Health Insurance Premiums

Employees can pay their share of health insurance premiums through payroll deductions, allowing them to save on taxes.

Dental & Vision Insurance

Offering dental and vision insurance under a Section 125 plan can be a cost-effective way to enhance your employees’ benefits package.

Flexible Spending Accounts (FSAs)

As mentioned earlier, FSAs allow employees to set aside pre-tax money for medical or dependent care costs.

Commuter Benefits

Some Section 125 plans can even cover transportation costs, such as commuter benefits for public transit or parking expenses.

How to Set Up a Section 125 Plan for Your Business

Setting up a Section 125 plan involves a few key steps, but it’s relatively straightforward. Here’s a basic guide:

1. Choose Your Benefits
   Decide what benefits you’ll offer through the plan. Common options include health, dental, vision, FSAs, and commuter benefits.

2. Draft Plan Documents
   Create formal plan documents that describe how the plan works, the benefits offered, and the rules for elections and enrollments.

3. Implement Payroll Deductions
   Work with your payroll provider to ensure that deductions are made from employees’ paychecks before taxes.

4. Notify Employees
   Make sure employees are aware of the benefits available and provide clear instructions on how to enroll.

5. Comply with IRS Rules
   Ensure that your plan complies with all relevant IRS rules. This includes adhering to annual limits for certain benefits and ensuring that elections are made within a specific timeframe.

FAQs About Section 125 Plans

1. Can I offer both pre-tax and post-tax benefits?

Yes! Section 125 plans allow you to offer both pre-tax and post-tax benefits. Pre-tax benefits will lower employees’ taxable income, while post-tax benefits are not eligible for tax savings.

2. Are there limits on how much employees can contribute to FSAs?

Yes, there are limits set by the IRS for contributions to flexible spending accounts. For 2023, the limit is $2,850 per year for healthcare FSAs. These limits can change, so it’s important to stay updated.

3. Do I have to offer all types of benefits under a Section 125 plan?

No, you can select which benefits to offer, depending on the needs of your employees. Some businesses may only offer healthcare premiums, while others may also include commuter benefits or dependent care assistance.

4. What happens if employees don’t use all of their FSA funds?

FSAs typically have a “use-it-or-lose-it” policy. If employees don’t spend their FSA funds by the end of the year (or the grace period), the remaining funds are forfeited. However, some plans allow employees to carry over a small amount to the next year.

Conclusion: Is a Section 125 Plan Right for Your Business?

Implementing a Section 125 plan can be one of the most effective ways to offer flexible, tax-advantaged benefits to your employees. Whether you’re offering health insurance premiums, dependent care assistance, or FSAs, a cafeteria plan provides flexibility, reduces costs, and boosts employee satisfaction.

If you’re looking to enhance your benefits package while saving money on payroll taxes, a Section 125 plan is worth exploring.

Ready to dive deeper into employee benefits? Contact The Policy Shop today to schedule a consultation, or learn more about other ways to enhance your company’s offerings!