What a Section 125 Cafeteria Plan is and the pros and cons of it for individuals (This page was updated on 7/7/2007) In June 2007, the Connector issued its final Regulations on Section 125 Cafeteria plans. - The AF is still going over these regs and will post the requirements as soon as we can in an easy to understand format.

The definition of a Section 125 Cafeteria plan: "An employee benefit arrangement allowed by IRS Code Section 125, under which employees are allowed to pay for certain employee benefits on a pretax rather than an after-tax basis. Cafeteria plans, also known as Section 125 plans (because of the section of the IRS code that covers them), and flexible spending plans allow employees to use pretax dollars to choose among different types of benefits. Cafeteria plans typically have core benefits such as medical and life insurance, sick leave and sometimes disability benefits. Option benefits may include anything from dental insurance and elder care to vision coverage. They can't, however, include transportation assistance, tuition assistance or, unless part of a 401(k) plan, retirement benefits." Quoted from entrepreneur.com

The MA health care reform law has mandated that employers with over 11 employees* must offer a Section 125 Cafeteria Plan to their workers** to pay for their health care premiums. The self employed are not eligible, due to federal law, to participate in a Section 125 Cafeteria Plans (there are other exceptions and as soon as we get those in writing we will post them on this section). The new law does not say that an employer, employee of a business, or an individual has to contribute to a Section 125 Cafeteria Plan. Those employees who decline to participate in Section 125 Plan will be required to sign a HIRD employee form that will be submitted to the Department of Revenue. This form is now available to employers.

So what does this actually mean? A Section 125 Cafeteria Plan reduces the amount of taxes both an employer and employee pays. It also reduces the employee's /individual's gross income. So let's say you earn $1500 per month (pretax/ pre-withholding) at your job. Your health insurance premium through work is $300 per month and you put that $300 dollars into a 125 Cafeteria Plan to pay for your premium. Your taxable income for that month is reduced from $1500 to $1200.

This also means that your employer saves on their payroll taxes if you do take advantage of a Section 125 Cafeteria Plan. By reducing your gross pay, your employer pays less social security, Medicaid, worker's comp, and unemployment taxes for you as a worker. You as an employee save on your income taxes and you may take home a pay increased due to your gross income being decreased to a lower tax bracket, thus causing less taxes to be withheld. Short term this may seem like a great thing...

HOWEVER, there are some potential long term draw backs from participating in a Section 125 Cafeteria Plan. By knocking yourself down to a lower tax bracket, you could potential hurt your future social security payments when you retire or partially retire. Remember by reducing your gross pay, both you and your employer pay less social security tax. YOU, however, did not work less or earn less in reality, but by "accounting magic" you reduced your so called gross income, your tax burden, AND your social security payments. This is very important for low income workers, the self-employed, and those workers who do not have retirement plans to understand.

Also your potential worker's comp and unemployment benefits will be reduced by utilizing a Section 125 Cafeteria Plan, as they too are based on what you have earned in your gross income.

Remember the old saying, "There is no such thing as free money."

 

*Please note that the AF is trying to find out the correct definition and calculation on how an employer defines the number of employees.

**full time workers (those who work 35 hours or more per week) will be able to participate in a Section 125 Cafeteria Plans BUT only part time workers who work an average of 64 hours per month will be eligible under the law to participate in a Section 125 Cafeteria Plan

Employers may specifically exclude the following "employees" from participating in a Section 125 Cafeteria Plan: a) Employees who are less than 18 years of age, b) Temporary Employees (an individual who works on either a full or part time basis;whose employment is explicitly temporary in nature and does not exceed 12 consecutive weeks during the period of October 1 though September 30), c) Part-time Employees working on average, fewer than 64 hours per month for an Employer, d) Employees who are considered wait staff, service employees or service bartenders (as defined by in M.G.L. c. 149, section 152A) and who earn, on average, less than $400 in monthly payroll wages, e) Student Employees who are employed as interns or as cooperative students, f) Employees whose employer is required to contribute to a multi-employer Health Benefit Plan based on their employment, and g) Seasonal Employees who are international workers with either a U.S. J-1 student visa, or a a US H2B visa and who are also enrolled in travel health insurance.