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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. Employers could offer alternatives instead of the traditional health and perhaps life insurance coverage. With flexible benefits, a young parent can choose to put money towards childcare, while an older worker can choose to put more toward their retirement.
Flexible benefits apply to all employees whose employers participate in alternative plans where employees can make customized benefit plan choices.
Cafeteria plans. Flexible benefit plans are often referred to as cafeteria plans, as participants can choose from a “menu” of offerings. In such types of plans, participants are provided with a predetermined amount of employee dollars or credits on which to spend on their benefit choices. These types of plans became more popular when the 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 and choose between taxable and nontaxable (qualified) benefits.
Employer contributions to the cafeteria plan are usually made pursuant to salary reduction agreements between the employer and the employee in which employees agree to contribute a portion of their salaries 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 the Federal Insurance Contributions Act (FICA) and the Federal Unemployment Tax Act (FUTA).
Flexible spending accounts (FSAs). Employers may offer flexible spending accounts to employees. These may stand alone or be offered under a cafeteria plan. FSAs include health flexible spending accounts 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:
Plan designs. Employers may design such flexible benefits in a number of 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.
Pre-designed packages. 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 insured plan. If an employee chooses a lower cost package, the difference in cash can be recouped.
Employers can be creative in designing their plans. However, as a result of the Patient Protection and Affordable Care Act (PPACA), the annual contributions to a medical flexible spending account (FSA) is limited, with the specific amount revised annually for inflation.