Section 125 of the IRC allows employees to pay for a variety of benefits with pretax dollars, thus reducing the amount of their wages that are subject to federal income and employment taxes. Employers also get a tax savings because their share of employment taxes is also reduced. The "qualified" benefits that may be provided through Section 125, or flex or cafeteria, plans include health insurance, disability insurance, group term life insurance, group legal services coverage, elective contributions to 401(k) plans, adoption assistance, and medical and childcare reimbursements. The Internal Revenue Service (IRS) says that both a health savings account (HSA) and a high-deductible health plan (HDHP) associated with the HSA may be offered as options under a cafeteria plan. Thus, an employee may elect to have pretax salary reductions contributed as employer contributions to an HSA and an HDHP. Certain benefits such as long-term care insurance may not be funded with pretax dollars through a 125 plan.
There are three major types of flexible benefit plans, including:
• The premium-only plan, which is the simplest and least expensive to administer;
• The childcare, adoption assistance, and medical flexible spending account (FSA); and
• The full-scale flexible benefit plan (aka cafeteria plan), which is the most complicated to operate.
An employer may adopt each or all of the flexible benefit plan types.
Warning: Flexible benefit plans involve complex tax rules and should not be implemented without consulting a tax adviser who specializes in employee benefits.