SECTION 125

SECTION 125

A Section 125 plan is part of the IRS code that enables and allows employees to take taxable benefits, such as a cash salary, and convert them into non-taxable benefits. These benefits may be deducted from an employee's paycheck before taxes are paid. Cafeteria plans are particularly good for participants who have regular expenses related to medical issues and child care.  Depending on where they live, participating employees can save from 20% to 40% in combined federal, state, and local taxes on a variety of items that they typically already purchase with out-of-pocket post-tax funds. Employers can save an additional 7.65% on their share of payroll taxes.

A Section 125 plan typically lets employees use pre-tax money to pay for health insurance premiums (medical, dental, vision). Other options include retirement deposits, supplemental life or disability insurance, Health Savings Accounts, and various medical or dependent care expenses.

A Section 125 premium-only plan (POP) is a cafeteria plan that allows employees to pay their health insurance premiums with tax-free dollars. As the name implies, these premiums are the only expense funds can cover. The premiums can be for employer-sponsored insurance plans or certain individual health policies. POPs are one of the most common types of Section 125 plans.

The Section 125 rules specifically prohibit the following individuals from participating in plans:

  • Self-employed individuals

  • Partners within a partnership

  • Shareholders who own more than 2% of a subchapter S corporation

A wide variety of medical and child care expenses are eligible for reimbursement under a Section 125 plan. As for medical items and treatments, dozens of eligible expenses can be reimbursed.  There are also a large variety of eligible over-the-counter items that are eligible for reimbursement.

Section 125 plans require employees to use any remaining funds in the account by the end of the year or the money is forfeited to your employer. A carryover provision does allow plan participants to extend unused funds from one year to the next.  For 2023, the carryover limit is $610.  There is also a Grace Period that can be implemented that gives employees an extra 2½ months from the end of the plan year to spend any remaining funds.  The Section 125 Plan can offer one non-forfeiture option or the other, but it cannot offer both.