05 May What Is a Section 125 Cafeteria Plan? (And Why Smart Employers Use One)
modern employee benefits
Running a business isn’t cheap—especially when you’re trying to offer great benefits while managing tight margins. Between rising healthcare costs and the pressure to stay competitive in today’s job market, employers need benefit solutions that deliver real value without draining the budget.
Enter the Section 125 cafeteria plan—a powerful, IRS-approved way to offer pre-tax benefits that save money for both you and your employees.
Let’s break it down in simple terms: what it is, how it works, and why it might be the best benefit you haven’t implemented yet. (What Is a Section 125 Cafeteria Plan? And Why Smart Employers Use One | The plan saves employers & employees money through pre-tax benefits.)
What Is a Section 125 Plan | Cafeteria Plan?
A Section 125 plan, also known as a cafeteria plan, is a tax-advantaged benefit program that allows employees to pay for eligible expenses—like health insurance premiums, dental care, or medical copays—using pre-tax dollars.
Instead of paying for these costs out-of-pocket after taxes, employees can deduct the amount directly from their paycheck before taxes are calculated. This lowers their taxable income—and your payroll tax liability as the employer.
How Section 125 Plans Work (Without the Jargon)
The concept is simple: under IRS Code Section 125, employees can “choose” between taxable income and certain non-taxable benefits—hence the term cafeteria plan.
Employees select from a menu of options, which may include:
Health insurance premiums
Dental and vision coverage
Dependent care assistance
Health savings accounts (HSAs) or flexible spending accounts (FSAs)
Supplemental benefits like accident or critical illness coverage
By opting in, employees use pre-tax dollars, reducing their taxable income. Employers also benefit by lowering FICA tax obligations, making it a win-win.
📖 Learn more directly from the IRS cafeteria plan overview.
Why Employers Should Care About Pre-Tax Benefits
Offering a Section 125 plan isn’t just a nice perk—it’s a strategic move.
✅ Tax Savings for Employers
Every dollar shifted into pre-tax benefits reduces your payroll tax liability. Employers typically save around 7.65% in FICA taxes on each dollar of employee contributions.
✅ Boosted Take-Home Pay for Employees
Employees keep more of their earnings, which boosts morale and financial wellness without requiring you to raise salaries.
✅ Stronger Recruitment & Retention
Modern employees expect smarter benefits. A Section 125 plan shows your company is forward-thinking and values its people.
Our Section 125 Benefit Solution: The Champ Plan
If you’re looking for a turnkey, compliant way to implement a Section 125 plan, check out our Section 125 benefit solution: The Champ Plan.
It’s a fully managed program that includes:
Medical reimbursement benefits
IRS-compliant documentation
Minimal employer admin
Built-in wellness perks
Seamless employee enrollment and support
And best of all? It’s budget-friendly and scalable—even for small businesses.
Real Benefits You Can See Month-by-Month
Here’s how a Section 125 plan helps reduce taxable income on a monthly basis:
📊 Infographic Idea: Timeline of how a Section 125 plan reduces taxable income month-by-month.
Example: One Employee, $400 Pre-Tax Deduction
Employee gross pay: $4,000
Pre-tax benefits elected (Section 125): $400
Taxable income: $3,600
Employer saves ~7.65% in payroll taxes on $400 = $30.60/month
Multiply that across 20 employees and you’re saving over $7,000/year—without cutting checks or raising salaries.
5 Big Reasons Employers Are Adding Section 125 Plans in 2025
Tax relief for both sides of the paycheck
No disruption to existing health insurance or benefit programs
Boosted employee satisfaction through higher take-home pay
Improved recruitment messaging for job listings
Simple compliance with IRS rules when implemented properly
In short: it’s one of the few benefits that actually pays for itself.
FAQs About Section 125 Plans
❓ What expenses qualify under a Section 125 plan?
Eligible expenses include health insurance premiums, dental and vision coverage, FSAs, HSAs, and dependent care assistance. Some plans can also include supplemental benefits.
❓ Who can participate?
Generally, all full-time employees can participate. Some restrictions apply for owners or highly compensated employees, depending on plan design.
❓ Do employers save money too?
Yes—employers typically save 7.65% in payroll taxes on every dollar contributed to the plan. It’s one of the most cost-effective benefits available.
Final Thoughts: Make Smarter Benefits a Reality
In a world where benefit costs are climbing and employee expectations are rising, a Section 125 plan offers rare alignment: lower costs, higher value, and simplicity.
Whether you’re a company of 5 or 500, this strategy can free up budget, boost employee satisfaction, and differentiate you from competitors.
✅ Schedule a free benefits consultation with The Policy Shop today
Let us show you how our Section 125 benefit solution can fit your team and your goals—with no hassle and maximum return.