I am writing this post because I realize most Americans do not understand how a Cafeteria Plan (also known as a "Section 125 Plan") works. The amazing thing is that virtually all Americans utilize (or have access to) a Cafeteria Plan at some point during their working career, yet many do not take full advantage of them. As a tax-paying American citizen, you should understand how a Cafeteria Plan works because, when utilized correctly, a Cafeteria Plan can increase your take-home-pay without any change in your expenditures.
What is a Cafeteria Plan?
A "Cafeteria Plan" (see Section 125 of the IRS Code) is a benefit provided by an employer which allows an employee to contribute a certain amount of his or her gross income to a designated "account" before taxes are calculated. This "account" can be used to reimburse the employee for insurance premiums, medical, or dependent care expenses throughout the plan year or claim period as the employee incurs qualified expenses.
Essentially, a cafeteria plan allows an employee to reduce their gross income, effectively reducing the amount they pay in Federal, Social Security, and some State taxes. This amounts to a savings of between 25% and 40% of every dollar they contribute to the plan. The employer also realizes savings on FICA withholding tax for each participating employee.
Ask your employer about Cafeteria Plans because they save you and your company money on taxes. Utilizing a Cafeteria Plan correctly should result in an increased net paycheck.
Some common examples of Cafeteria Plans include:
1) Premium Only Plan (aka POP, to be discussed in a future blog post)
2) Flexible Spending Accounts (aka FSAs, see An Overview of FSAs)
3) Contributions to Health Savings Accounts (aka HSAs, see What is a Health Savings Account)