Let’s say we could offer you a way to reduce your small business’ payroll taxes. Now, let’s say we could offer you a way for employees to reduce their taxable incomes. If we could provide both of these benefits in one package, would you take our offer? Of course you would!
So, Small Business Owner, let us introduce you to the Section 125 Plan. It’s an uninspired name for a benefits plan that cuts taxes — and saves money — for you and your small business employees.
What Is A Section 125 Plan?
Section 125 is an IRS code that allows employees to convert a portion of their taxable income into non-taxable income. Therefore, a Section 125 Plan (also known as a Cafeteria Plan) meets Section 125’s specific requirements.
The point of a Section 125 Plan is to make employer-sponsored coverage more affordable to employees. Under this plan, employees agree to contribute a certain amount of their gross income for specific medical expenses — like health insurance premiums or out-of-pocket costs — before taxes are deducted from their paychecks. These pre-tax dollars are set aside in a designated “account.” We’ll go over each these account options below.
Premium Only Plan (POP)
The POP is the most common type of Section 125 Plan. With a POP, the employee pays for part of their insurance premiums (including health, dental, and/or vision) before taxes are calculated.
Flexible Spending Account (FSA)
With an FSA, the employee agrees to set aside pre-tax income to pay for certain out-of-pocket costs that aren’t covered by their health insurance plan. These expenses can include deductibles, co-pays, prescriptions, orthodontia, etc. Some plans allow employees to roll over a portion of their unused funds, but typically, unused funds from an FSA are distributed to the employer at the end of the plan year.
Dependent Care Assistance Plan (DCAP)
A DCAP is a type of FSA that allows employees to reserve up to $5,000 of their pre-tax income for certain healthcare expenses for employees’ dependents. These services include day care, nursery or preschool, before or after-school care, and adult day care.
In regards to Section 125, the main distinction between the POP and FSA is this: POPs are set aside to pay for health insurance premiums, and FSAs are set aside to pay for out-of-pocket medical expenses.
Health Savings Account (HSA)
An HSA is a financial account set up by an employee to pay for medical expenses. Under the Section 125 Cafeteria Plan, the employee or employer can make pre-tax contributions to the employee’s HSA account.
HSAs have a triple tax advantage:
- Account holders can contribute pre-tax dollars into the HSA account.
- Account funds grow tax-free.
- Account holders can withdraw funds tax-free (as long that money is used for approved medical services).
How Section 125 Plans Benefit Employees
Cafeteria Plans reduce the employee’s taxable income, which decreases the amount they pay in state, federal, and Social Security taxes. As a result, employees save 20 to 40% of every dollar they contribute to a Cafeteria Plan.
How Section 125 Plans Benefit Employers
With a Section 125 Plan, employers reduce their tax liability. Here’s how it works: The employee agrees to contribute a portion of their pre-tax income for certain healthcare benefits. Because these contributions are set aside in an “account” — in the form of a POP, FSA, or HSA — they are not considered employee wages. Therefore, the amount set aside for an employee’s Section 125 Plan is not subject to federal payroll taxes (including FICA, FUTA, and Social Security and Medicare taxes).
Set Up A Section 125 Plan With Regency West
Section 125 / Cafeteria Plans give employees a way to use pre-tax income to pay for health insurance premiums or out-of-pocket costs. The end result: Everybody wins. You, the employer, save on local, state, and federal taxes. And your employees decrease their taxable income and increase their take-home pay.
To set up a Section 125 Plan for your small business, talk to a licensed health insurance agent at Regency West Insurance Services. We will help you set up a Cafeteria Plan — with a POP, FSA, or HSA — that suits your business needs.
Visit us at RegencyWestInsurance.com or call us at (858) 699-0286. We can’t wait to hear from you!