What is a Cafeteria Plan?
Why Do Employers Propose Cafeteria Plans?
How Does a Cafeteria Plan Work?
What Benefits can be Included in a Cafeteria Plan?
Possible Problems
Limited Cafeteria Plan

What is a Cafeteria Plan?

Cafeteria plans are defined under Section 125 of the Internal Revenue Code as plans maintained by an employer that allow each participant to select among cash and one or more qualified non-taxable benefits. This is the technical definition, but in practice a cafeteria plan (sometimes called a flexible benefit plan) is a benefit plan that allows an employee to have some choice in designing his or her own benefit package by selecting different types and/or levels of benefits that are funded with nontaxable employer dollars.

Why do Employers Propose Cafeteria Plans?

Many employees are initially enthusiastic about cafeteria plans because they believe that they will be able to acquire new benefits, such as child care assistance or orthodontia coverage, which they believe will suit their particular needs. However, Unions and their members need to be very wary of proposed cafeteria plans. Many employers implementing cafeteria plans claim the plan will better meet individual needs. The reality is that most employers introduce cafeteria plans to reduce employer benefit costs. Many employers with newly implemented cafeteria plans changed their medical plan design by raising deductibles and/or increasing employee contributions. Satisfying diverse employee needs is, at best, a secondary objective.

How does a Cafeteria Plan Work?

• The most common type of cafeteria plan provides a basic core of benefits including minimal levels of medical and life insurance, sick leave or disability benefits, plus a second layer of optional benefits. At a minimum, the basic benefits should provide a reasonable level of protection against the major sources of personal risks. The employee can select the core benefit, or alternatively, purchase a higher level of benefits with cafeteria dollars. The plan might also add benefits that were not previously offered as options.

   

• Each employee is allotted a predetermined number of dollars, credits, or points with which he or she may purchase benefits from options made available by the employer. If the dollar amount allotted by the employer is inadequate to purchase the desired benefits, some plans allow employees to make additional purchases with before-tax contributions through payroll deduction.  If the benefits selected cost less than the allotted amount, the employee receives the difference in cash, if the plan so provides. The cash amount is taxable as ordinary income.

What Benefits can be Included in a Cafeteria Plan?

• Benefits which can be offered in a cafeteria plan include most benefits ordinarily resulting in no taxable income to employees if provided outside of a cafeteria plan. Some examples are: health, dental and life insurance, accidental death and dismemberment coverage, disability coverage and vacation leave. One exception, group life insurance in excess of $50,000, which is normally taxable, can be included. Although the inclusion of life insurance coverage is permitted, the amounts in excess of $50,000 continue to be taxable.

   

• Although scholarships, fellowships, transportation benefits, educational assistance, and employee discounts are not taxable benefits, they are an exception to the above rule and may not be included in a cafeteria plan.

   

• A cafeteria plan cannot include retirement benefits except under a 401(k) plan. However, because the regulations governing 401(k)s are so complex, especially when combined with IRS Section 125 regulations, many employers will not allow their inclusion in a cafeteria plan.

Limited Cafeteria Plan

    Limited cafeteria plans are appropriate when employees and their dependents are fully covered by health, dental, vision, health screening, hearing, well-baby care, life insurance and disability plans.  A limited plan may offer spending credits or dollars to be used to purchase non-traditional benefits such as increased vacation days, child care, term insurance on dependents, financial counseling, additional life insurance and/or legal services. If the union is considering participating in this type of program, the choices offered and the level of benefits should remain subject to negotiations.

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