Section 125 - Cafeteria Plans

Employees who are enrolled in a Section 125 plan can set aside insurance premiums and other funds pretax, which can then go toward certain qualified medical expenses. Depending on where they live, participating employees can save from 20% to 40% in combined federal, state, and local taxes on a variety of items that they typically already purchase with out-of-pocket post-tax funds. Employers can save an additional 7.65% on their share of payroll taxes.
 

Section 125 plans offer employers a lot of tax-saving benefits. Employers save on the Federal Insurance Contributions Act (FICA) tax, the Federal Unemployment Tax Act (FUTA) tax, the State Unemployment Tax Act (SUTA) tax, and workers' compensation insurance premiums for each participant in the plan. Combined with the other tax savings, the Section 125 plan usually funds itself because the cost to open the plan is low.

As an added advantage, employees receive an effective raise without any additional cost to the employer. More participants in the plan equate to more tax savings for the employer so the employer is often encouraged to contribute to each employee's plan to promote increased participation by those who are not yet in the Section 125 plan.
 

The primary benefit is also tax-related for employees. A participant can typically expect to save 20% to 40% of every dollar put into the plan.3 The amount that the employee decides to put into the plan must be chosen each year. The "election" amount is deducted from the employee's paycheck automatically for each payroll period.
 

Section 125 plans do state that you must use any remaining funds in the account by the end of the year or the money is forfeited to your employer.5 But a carryover provision that was implemented in 2013 does allow plan participants to extend up to $500 of unused funds from one year to the next.

Contributing to a cafeteria plan may still result in a net benefit even if you do get dinged by an excess amount of funds. Assume that you placed $1,000 in your Section 125 plan. You notice that you have $100 remaining in the account at the end of the year. You've already saved $240 on taxes ($1,000 x 24%) if you're in the 24% marginal tax bracket. Forfeiting the $100 means that you still have a net benefit of $140.