What is a cafeteria plan?

Generally, a cafeteria plan (sometimes called a flex plan) is a separate, written benefit plan maintained by an employer under which all participants are employees and each participant has the opportunity to select among a range of offered benefits. A cafeteria plan must allow employees to choose between receiving cash (a taxable benefit) and at least one "statutory nontaxable benefit."

Cafeteria plans are permitted under Section 125 of the Internal Revenue Code. Plan choices can be:

• among different levels of the same benefit (such as different health plans); or
• among different types of benefits (such as between life insurance, dental insurance, and vision benefits).

Code Sec. 125 requirements. In order for a flex plan to be a cafeteria plan and keep its tax-favored status under Code Sec. 125, the plan must:

• permit employees to choose between two or more benefits, consisting of at least one nontaxable benefit and cash;
• be a written plan;
• be for employees only (i.e.,allow only employees to participate);
• not include any benefit that defers the receipt of compensation; and
• require participants to make annual benefit elections.

Cafeteria plan design. A cafeteria plan can be, for example:

• a salary reduction program that converts employee premiums for benefits from an after-tax to a pre-tax basis (sometimes called premium only plans (POPs) or premium conversion plans);
• a flexible spending account (FSA), which allows employees to pay for health or dependent care expenses with pre-tax dollars;
• a menu of benefit choices, including pre-tax and after-tax benefits, multiple benefit plans (such as a choice among several health plans, PPOs, and HMOs), cash, vacation benefits, or 401(k) plan elective contributions; or
• all of the above.

These choices may be structured as individual plans, as modular combinations of plans, or as a core of basic benefits plus options.

Who foots the bill? A cafeteria plan can be funded by employer or employee contributions or a combination of both.

Reprinted with permission. © CCH