Cafeteria Plan (Section 125)
A cafeteria plan (Section 125 plan) allows employees to choose from various pre-tax benefits including health insurance, FSAs, and dependent care, reducing taxable income through salary reduction.
Exam Tip
Section 125 = cafeteria plan. Pre-tax benefits reduce taxable income AND FICA. Use-it-or-lose-it for FSAs. Cannot include LTC or 401(k).
What is a Cafeteria Plan?
A cafeteria plan, authorized under IRC Section 125, lets employees choose from a menu of tax-free benefits using pre-tax dollars via salary reduction.
Qualified Benefits (Tax-Free)
| Benefit | Description |
|---|---|
| Health Insurance | Medical, dental, vision premiums |
| FSA | Flexible Spending Account (medical/dependent care) |
| HSA | Health Savings Account contributions |
| Dependent Care | Up to $5,000/year |
| Adoption Assistance | Qualified expenses |
| Group Term Life | Up to $50,000 coverage |
Non-Qualified Benefits (Cannot Include)
- Long-term care insurance
- Qualified scholarships
- 401(k) contributions (separate)
- Health Savings Account (HSA) alone
Tax Advantages
| Tax | Treatment |
|---|---|
| Federal Income | Exempt |
| FICA (Social Security/Medicare) | Exempt |
| State Income | Usually exempt |
Use-It-or-Lose-It Rule
FSA funds generally must be used by year-end, with limited exceptions:
- 2.5-month grace period, OR
- $640 rollover (2024)
Study This Term In
Related Terms
HSA (Health Savings Account)
An HSA is a tax-advantaged savings account for individuals with high-deductible health plans, offering triple tax benefits: tax-deductible contributions, tax-free growth, and tax-free withdrawals for qualified medical expenses.
401(k)
A 401(k) is an employer-sponsored retirement savings plan that allows employees to contribute pre-tax dollars, with potential employer matching, and tax-deferred growth until withdrawal.
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