What is it?

1. What is it? A plan that allows employees, within limits, to chose benefits from a “cafeteria” of benefit plans provided by their employer Cafeteria plans MUST include a “cash option”

2. When is it indicated? • Benefit needs of employees vary greatly • Employees want to choose benefits to suit own needs • Employer wants to maximize employee satisfaction with benefit package • Employer is large enough to afford expense of such a plan

3. Advantages • Employees more likely to appreciate value of their benefit package • Flexibility of cafeteria plans help meet various employee needs • Cafeteria plans can help control employer costs since employees select only the benefits that they want

4. Disadvantages • Complex and costly to design and administer • Not all insurers will provide their programs on a cafeteria plan basis (e.g., life and health) • Plan must meet complex tax requirements • Highly compensated employees may lose tax benefits if plan discriminatory

5. Example of Cafeteria Plan • All employees given basic benefit package with • term life insurance equal to 1½ times salary • medical expense insurance for employee and dependents • short and long-term disability income insurance • Employees also receive “credits” based on salary and years of service that can be applied to additional benefits specified by the employer

6. Tax Implications • Cafeteria plans must comply with IRS Code Section 125 to avoid constructive receipt and consequent tax on value of benefits available in the plan, even if participant chooses nontaxable benefits

7. Tax Implications • Under Section 125, only certain ‘qualified benefits’ can be made available under the plan • “Qualified benefits” under a cafeteria plan • cash • most tax-free benefits under the Code EXCEPT • Archer Medical Savings Account contributions (HSAs are permitted) • scholarships and fellowships under Section 117 • educational assistance under Section 127 • employee discounts and other fringe benefits under Section 132 • retirement benefits (a 401(k) is permitted, however) • long term care insurance

8. Tax Implications • Cafeteria plans have nondiscrimination requirements • Participation • does not discriminate in favor of highly compensated employees • covers all employees with 3 years of service • Benefits • benefits for highly compensated employees must be within limits given by tax code • If fail nondiscrimination tests, highly compensated employees taxed on otherwise nontaxable benefits • All benefits under plan must meet own non-discrimination requirements

9. Alternatives Flexible spending account (FSA) • special type of cafeteria plan funded with salary reductions Fixed benefit programs without employee choice • best when employees have same benefit needs • simple to administer Cash compensation • forfeits tax advantages in favor of maximum employee choice • assumes employees will have adequate income to purchase own benefits

10. How Are These Plans Set Up? • Employer decides plan design based on employee needs and cost • Draft and adopt written plan; IRS approval not necessary • Design and distribute employee election forms (for choice of benefit); employee choices made in advance of year benefit earned • Effectively communicate plan to employees; key factor in plan success

11. True or False? • Cafeteria plans raise benefit costs for all employees. • If a plan is discriminatory, the highly compensated may lose their tax advantage under the plan. • Long term care insurance can be offered in a cafeteria plan. • Cash compensation is an alternative to a cafeteria plan.

12. Discussion Question What is the value of offering employees a cafeteria plan instead of offering the same benefits to all employees? How can an employer judge whether the additional plan complexity and expense of a cafeteria plan is worth it?