Cafeteria Plan

Definition - What does Cafeteria Plan mean?

A cafeteria plan, as outlined under Section 125 of the Internal Revenue Service Code, is a savings option that allows an employee to pay a designated amount of their gross income into the account before the government calculates taxes. This allows the employee to reduce their taxable income and lowers the total amount paid for certain state taxes, federal income taxes, and Social Security taxes.

Justipedia explains Cafeteria Plan

The savings can be substantial. For example, some employees can save between 25 and 40% of every dollar that they contribute to the cafeteria plan, and the money paid into the plan can be used for medical expenses, dependent care expenses, or insurance costs. The plans offered may vary, but often include health savings accounts, flexible spending accounts, and premium-only plans.

The cafeteria plan is maintained between the employee and the employer. It must be created to clearly designate all taxable and qualified benefits offered through the plan, and must outline the requirements for eligibility.

The benefit of the cafeteria plan is its flexibility, which includes allowing the employee to choose the benefits they need. For example, employees may estimate the amount of money needed for child care in the upcoming year, request that their employer subtract that amount from their wages, and have the designated amount put into their cafeteria plan.

Due to the administrative complexity of a cafeteria plan, many small business employers benefit from hiring a third-party administrator to manage the plan and to ensure that the plan complies with federal tax regulations. Companies who do not understand how to manage the plan properly could face high fines for non-compliance.

Talk to your cafeteria plan administrator if you have questions about whether your company offers this type of benefit and the maximum annual election established by your company. In some cases, the benefits of the cafeteria plan may also be offered to dependents, spouses of employees, and, under certain conditions, former employees.

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