Cafeteria plan (Section 125)

Definition

A cafeteria plan (named for IRS Code Section 125) is a benefits arrangement that allows employees to elect certain benefits — health insurance premiums, FSA contributions, dependent care assistance — and pay for them with pre-tax dollars. This reduces both employee income tax and the FICA wage base, saving roughly 25-35% of the elected amount depending on tax bracket.

Cafeteria plans require formal plan documents and annual nondiscrimination testing to prevent disproportionately benefiting highly compensated employees. The compliance overhead is non-trivial for small employers.

In a PEO arrangement, the PEO maintains the cafeteria plan documents for the co-employed workforce — handling the nondiscrimination testing, election processing, and IRS reporting requirements automatically.

Common questions about Cafeteria plan (Section 125)

Related terms

• Group health insurance — Health insurance purchased by an employer to cover its employees, typically at lower per-employee cost than individual policies.
• Open enrollment — The annual period when employees can elect, change, or drop benefits coverage for the upcoming plan year.
• Employee Retirement Income Security Act (ERISA) — A 1974 federal law that sets minimum standards for most voluntary pension and health plans in private industry.

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