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If your
employees are dissatisfied with their current benefits, it could be
because their needs are not being met. A cafeteria plan could be a
vehicle for building “choice” into your benefits program.
Many
employers offer a “one size fits all” benefits plan, and as a
result, do not provide the benefits their employees really want or
need. A cafeteria plan can remove the take-it-or-leave-it
proposition from your benefit offerings. This type of benefit plan
can empower your employees by allowing them to design their own
benefit packages. You have heard of cafeteria plans but may still
have a lot of questions, including: what is a cafeteria plan? how
does it work? what are the advantages and disadvantages?
Understanding some of these basics may help you decide if a
cafeteria plan is right for your organization.
What Is a Cafeteria Plan?
The
Internal Revenue Code (IRC), Section 125(d), defines a cafeteria
plan as a separate written document which gives participants the
choice between cash (a taxable benefit) and at least one other
benefit the Internal Revenue Service (IRS) calls a qualified benefit
(a nontaxable benefit), which is not included in the participants’
income for federal tax purposes. The plan document governs
contributions to and participation in other benefit plans, and only
employees may participate. You may think of it as the master
document that contains a collection of benefit plans offering a menu
of benefits. The type of cafeteria plan that is set up, whether very
simple or more complex, will make a difference in the cost of
administration. Regardless of the design, the IRS determines which
benefits may be offered in a cafeteria plan.
[Creating HR Policies or Employee Handbook?]
Benefits
Typically Offered under a Cafeteria Plan
Examples
of qualified (or nontaxable) benefits that may be offered under a
cafeteria plan include accident and health insurance, group-term
life insurance up to $50,000, business travel accident insurance,
coverage under a medical and/or dependent care flexible spending
account, and 401(k) contributions. Employers also can provide
certain taxable benefits, paid for using after-tax dollars,
including group automobile insurance, group homeowners insurance,
vacation days, and cash. Although these benefits are taxable, they
still are considered benefits since the employee may not otherwise
have access to them (in the case of additional vacation days and
cash) or may not be able to purchase them at the rate the employer
can (in the case of insurance).
On the
other hand, a cafeteria plan may not offer scholarships and
fellowships, transportation benefits, educational assistance,
employee discounts, and retirement benefits that defer the receipt
of benefits beyond the taxable year (other than participation in a
401(k) plan mentioned above).
Depending on the structure of the plan, the employee may pay for
benefits under the cafeteria plan, the employer may pay, or both may
pay a portion of the cost. If the employer pays part of the cost, it
may give the employee a certain number of dollars and the employee
must pay the difference for the benefits he chooses.
Advantages to Employees
A big
advantage for employees is that cafeteria plans allow them to choose
the benefits they need. For example, if an employee needs new
glasses or would like to have cosmetic surgery, he can put pre-tax
dollars into a health care spending account and purchase these items
within the plan year without paying federal taxes on money used for
the purchase. Or, if an employee is covered by a spouse’s medical
plan, he may decide to opt out of medical insurance and purchase
additional life insurance. In case the employee has a change in
family status during the year (for example, marries or has a baby),
he may have the option of changing his benefit choices to reflect
the change in family needs.
In
addition, employees can reduce their payroll taxes by purchasing
qualified benefits with pre-tax dollars. Because those benefits are
not taxable, the employee does not have to pay federal income tax
and social security tax on the dollars used to purchase them.
Advantages to Employers
Among
the advantages for employers is saving on payroll taxes. The
employee pre-tax payments will lower the employer’s overall payroll
and, as a result, will lower payroll-related taxes. In addition,
there may be a cost saving to the employer because the cost of
benefits that employees do not want will be eliminated. Employers
that currently pay the cost of benefits for employees also may
choose to shift some or all of the cost to employees through a
salary deferral arrangement (the employee’s salary is reduced or
deferred to pay for the benefit) by giving the employee a certain
number of dollars to spend on benefits of his choice. If the cost of
the employee’s benefits exceeds the dollars received from the
employer, the difference is deducted from the employee’s salary.
Even if the cost of benefits increases in successive years, the
employer can keep its cost constant by raising the employees’ share
of the premiums. Finally, cafeteria plans may help attract and
retain employees because they like the element of choice and the tax
advantages.
Disadvantages of the Plan
One
potential downside of cafeteria plans is the possibility of “adverse
selection,” the selection of a specific benefit by those who are
most likely to use it extensively while those who are not likely to
use it do not choose the benefit. For example, when a group of
employees who have costly medical needs all select the same medical
plan, claims under the plan will increase. With higher claims to
pay, the cost of the insurance also will increase, causing healthy
employees to choose not to participate in this benefit. As a result,
the price of the insurance may increase so much it is no longer
practical for the employer to maintain the plan. Another
disadvantage is the complexity and cost of administration since
employers must comply with the extensive regulations that govern
cafeteria plans, including tax nondiscrimination rules and the
Employee Retirement Income Security Act (ERISA) reporting and
disclosure requirements.
Getting
Started
If you
are considering a cafeteria plan, perhaps the most important first
step is to determine whether such a plan is feasible for your
organization, based on the goals of the employer and the needs of
the employees. Many employers conduct a study of the design and cost
of the benefits and use a benefits consultant specializing in
cafeteria plans. You also should analyze your employees’
demographics. Their ages, marital status, and number of dependents
will influence the cost and desirability of the benefits to be
offered. In addition, if the organization has insurance carriers,
you should consider the feasibility of offering current plans under
the cafeteria structure.
The
success of a new cafeteria plan depends on planning, which may take
as much as a year or more. One approach is to offer only the basic
health benefits at first. If the employees like the idea, the plan
can be expanded later. By researching the benefits and listening to
your employees’ needs, you can create the plan best suited to your
organization. |
Personnel
Policy Service, Inc.
