• Flexible benefit plans, often referred to as “cafeteria” or “Section 125” plans, may offer employees a “menu” of benefits that can be obtained with taxable or pre-tax dollars.
• Pre-tax (or qualified) benefits may include health care, vision and dental care, group-term life insurance, disability, and adoption assistance.
• FSAs offered to employees may stand alone or be offered under a cafeteria plan and may include health FSAs for expenses not reimbursed under any other health plan or dependent care assistance programs.

As the workforce evolved, employers saw a need to offer a variety of benefit choices as different employees had different benefit needs. Enter the concept of flexible benefits.

These types of plans are often referred to as cafeteria plans, as participants can choose from a “menu” of offerings. These types of plans became more popular when the Internal Revenue Service (IRS) provided some tax relief for what they refer to as “cafeteria” or “Section 125” plans. Now employees could obtain certain benefits with pre-tax dollars.

Cafeteria plans

Under the Internal Revenue Code (IRC), a cafeteria plan is a written plan under which participants may choose from two or more benefits consisting of cash and certain other benefits. In general, benefits that are excludable from the gross income of an employee under a specific section of the IRC may be offered under a cafeteria plan.

Employees can choose between taxable and nontaxable (qualified) benefits.

Qualified benefits include such things as health care, vision and dental care, group-term life insurance, disability, and adoption assistance.

Employer contributions to the cafeteria plan are usually made pursuant to salary reduction agreements between the employer and the employee in which the employee agrees to contribute a portion of his or her salary on a pre-tax basis to pay for the qualified benefits. The contributions are not considered wages for federal income tax purposes. In addition, those sums generally are not subject to FICA (Social Security and Medicare deductions) and FUTA (Federal Unemployment Tax). Employees and employers share in paying FICA taxes. FUTA is paid by the employer only.

Flexible spending accounts (FSAs)

Employers may offer FSAs to employees. These may stand alone or be offered under a cafeteria plan. FSAs include health FSAs for expenses not reimbursed under any other health plan and dependent care assistance programs.

With an FSA, employees can purchase benefits on a pre-tax basis through salary reduction.

There are a couple of drawbacks to FSAs. The first one is that employees have access to the entire fund, no matter how much is in their account. For example, if an employee has only two months’ worth of contributions in his account, he can access the entire amount that was to be accumulated.

Another drawback is the use-it-or-lose-it element. If an employee has any money left in his account at the end of the plan year, he forfeits it. This forfeiture must be used only for the payment of benefits and administration costs. The IRS extended the deadline to use the funds by 2.5 months after the end of the plan year.

HEART Act option: The Heroes Earnings Assistance and Relief Tax (HEART) Act allows for the taxable distribution of unused funds in health care FSAs for military reservists who are called to active duty. The Act also does away with the “use it or lose it” provision of FSAs for reservists. While this measure is optional, employers are encouraged to adopt it.

Plan designs

Employers may design such flexible benefits in several different ways. They can offer core benefits such as health and life insurance coverage and provide employees with a certain number of dollars or credits to obtain other optional benefits. The benefits could be, for example, additional life insurance, vacation days, vision coverage, or cash.

Employees may or may not contribute to the core benefits.

Plans can also have pre-designed packages from which employees may choose. In some situations, the plan may include different health care coverage options such as an health maintenance organization (HMO), a preferred provider organization (PPO), and a traditional insurance plan.

If an employee chooses a lower cost package, he or she can recoup the difference in cash.

Employers can be creative in designing their plans. However, because of the Patient Protection and Affordable Care Act (PPACA), the annual contributions to a medical FSA are limited, with the specific amount revised annually for inflation.