A cafeteria plan has nothing to do with
lunch or plastic trays with neat
dividers. There are no hairnets, milk cartons, or peas and carrots involved. In the
world of health insurance, a cafeteria plan
refers to a benefits program that allows
employees to select from a menu of options,
which may be tax-advantaged.
“Cafeteria plans are employer-sponsored
programs that give employees a way to save
on their medical benefits,” says Kimberly
Flett, CPA, QKA, an associate director in the
retirement plan design and administration
department at SS&G Financial Services, Inc.
Cafeteria plans are also known as Section
125 plans because of the IRS code that
defines them. The proposed regulations that
govern these plans have existed since the
early 1980s. Now, another set of regulations
has been proposed that reinforces many of
the original rules and adds a few changes,
most significantly to discrimination testing
that is designed to ensure that employers are
providing equal opportunity for all employees to participate in the cafeteria plan.
Proposed regulations were released in
August 2007, so employers can begin adhering to them immediately and must begin
using them by Jan. 1, 2009. The regulations
will remain proposed until the IRS issues
final regulations, if that is the case. Employers will need to be in accordance with
the proposed regulations even if they are not
issued in a final version.
Smart Business spoke with Flett about
cafeteria plans and the proposed regulations.
What are the components of cafeteria plans?
There are three major components to cafeteria plans, and employers can choose to
offer one or all of them. Each provides a vehicle for tax savings. The premium component
encompasses any welfare benefit a company
offers its employees, whether medical, vision
or dental insurance. Employees can deduct
their premium cost from payroll pretax,
which may result in an average of 28 to
32 percent annual tax savings. The second
component to a cafeteria plan is a flexible
spending account, which allows employees
the option to set aside pretax dollars from
their paychecks to help fund medical expenses, including supplies and prescriptions.
Rather than paying out-of-pocket for a prescription co-pay, an employee can use pretax
dollars for this purpose. The third component is dependent care, which provides a
$5,000 deduction — or a $2,500 deduction for
married couples filing taxes separately — to
caregivers of qualified dependents.
What rules are being re-emphasized in the
new proposed regulations?
A number of original rules are being redefined, reinforced and further explained so
employers who offer cafeteria plans better
understand what these programs should
include. First, employees who choose to participate in a cafeteria plan must do so exclusively. Employers must clearly spell out the
cafeteria plan through a written document
that includes legal terminology and explains
pretax benefits and other parameters. Also,
employers must provide employees with a
simplified summary plan description. This
document should be distributed to all
employees at the time of enrollment and
whenever the plan is updated.
Also emphasized in the proposed regulations is the requirement that employees elect
to participate in the cafeteria plan before the
beginning of the plan year, which is usually
Jan. 1. Employees can change their election midyear for major life events or qualified
changes of status, such as marriage, death of
a family member, birth of a child or a disability that changes working hours. Employees
must submit all receipts for expenses
incurred in a timely manner during the plan
year. All plan participants must be actively
employed, and employers cannot offer special plans for certain workers, such as retired
individuals or leased employees.
Another reinforcement pertains to a grace
period for flexible spending accounts.
Employees with money that wasn’t applied
to current-year medical expenses have two
and a half months in the following plan year
to spend those dollars on approved items,
including over-the-counter medications.
What new proposed regulations are important
for employers to note?
The new rules predominantly involve
discrimination testing. Employers must
ensure that the company generally offers
the same benefits to all employees, and
testing measures help enforce this rule.
There are four areas of discrimination testing: eligibility, contribution, benefits offerings and payment. Eligibility: Employers
must generally establish the same enrollment period for all groups of employees.
This prevents an employer from ‘playing
favorites,’ so to speak. Contribution: Employers give fairly to each employee’s plan.
Benefits offerings: Key employees must
not receive a greater proportion of benefits
than rank-and-file staff. Payment: Employers must again be sure that they pass testing if they decide to pick up a greater portion of a premium payment for supervisors
than for rank-and-file staff.
How does an employer know whether he or
she will pass discrimination testing?
It’s a good idea to consult with the payroll
provider first to be sure that all documents
are in order. Also, discuss the plan with a
professional who understands these programs and can offer advice on proposed
regulations and how they will affect the
company. <<
KIMBERLY FLETT, CPA, QKA, is an associate director in the retirement plan design and administration department at SS&G Financial
Services, Inc. Reach her at [email protected] or (800) 869-1835.
