What is a cafeteria plan?

A cafeteria plan is a benefit plan offered by employers that give employees the ability to choose from a range of benefits on a pre-tax basis. A pre-tax benefit refers to a benefit that is deducted from an employee’s paycheck before the federal government taxes the value of the benefit, thereby reducing the amount of taxable wages that an employee earns and pays taxes on. However, some benefits, such as cash, are considered taxable. Because taxes play a key role in a cafeteria plan benefit plan, this type of plan is governed by the Internal Revenue Code and is sometimes referred to as a Section 125 plan.

Common offerings of a cafeteria plan include contributions to health savings accounts, flexible spending accounts, retirement plans, group term life insurance, and adoption assistance plans. The flexible nature of these plans allows an employer's benefit plan to best fit a diverse workforce.

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When do I need to be aware of a cafeteria plan?

Cafeteria plans are often detailed during an employee’s hiring process. As part of an employee's enrollment, they'll choose which benefits toward which they'd like to make pre-tax contributions. Flexible spending accounts, a popular component of cafeteria plans, have strict requirements set in place by the IRS as to what the funds can be spent on without incurring taxes.

What is important to know about cafeteria plans?

Cafeteria plans offer advantages and disadvantages to employers and their employees. There are some other important items you should know about cafeteria plans:

Since these plans allow for pre-tax contributions, both employees and employers will have reduced tax liability.
However, any unused contributions by the employee are forfeited at the end of the year.
Typically, contributions must be determined at the beginning of the year and cannot be adjusted until the next year begins.
As cafeteria plans give employees the option to receive different benefits from one another, they are often complicated to administer and require a high level of communication between the employer and employee.