What is a Section 125 employer health insurance plan?
Section 125 of Title 26, United States Code created a specific exception to the tax laws that permitted employers and employees to establish flexible benefits programs that include health insurance.
The Section 125 cafeteria plan authorized taking pre-tax dollars from the employees gross income for the named purposes in Section 125 that include health insurance.
Employees could spend the contributions on qualified expenses including health insurance premiums, medical expenses, dependent care, medical supplies, and disability insurance.
The Affordable Care Act made changes in IRS Sec. 125 plans including popular premium only plans (POP).
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Customized Benefits Plans
The major contribution of Section 125 was in the flexibility it afforded for employees to tailor a benefits program to meet their needs and preferences. They could get health and other types of protection and coverage based on their needs and amounts they contributed.
The essential flexibility remained after the ACA but the reform law limited some applications of qualified benefits.
The Individual Mandate
Employees, like other Americas, must have health insurance coverage through an employer plan, the Obamacare Marketplace, or the private insurance market.
Employees with offers from an employer cannot use the marketplace if the employer-sponsored coverage is affordable.
Employers can no longer pay or reimburse individual employee health insurance. The fine for doing so can be as high as $36,500 per employee per year. The market reform of Obamacare requires employers to offer insurance all employees that meet the requirement of the law for coverage, expense limits, and minimum value.
The Employer Mandate
Employers with 50 or more full-time equivalent employees must comply with the mandate or face a penalty. Employers with 99 or more full-time equivalent employees must offer health insurance coverage that meets the requirements for qualified health insurance.
Section 125 Plans Offer Financial Assistance
Cafeteria plans covered more than health insurance. They avoid the uninsured penalties. As part of a customized benefits program, employees can choose to establish a bank account for paying health insurance and related health expenses. They could also pay expenses for a dependent, get life insurance, and buy up to higher levels of coverage. The Section 125 plans included the below-listed employee options.
- HSA – the Health Savings Account used employee funds on a pre-tax basis.
- FSA – the Flexible Spending Account used employer funds to reimburse expenses.
- HRA – the Health Reimbursement Account works with health plans to reduce expenses.
IRS Section 125
The IRS code defined a section 125 plan. The cafeteria plan had minimum formality and requirements but had a wide range of potential options.
As amended, the policy fits Obamacare market reforms and provides important benefits. The below-listed items describe the essential original requirements.
- The cafeteria plan must be a written plan.
- All participants must be employees.
- The plan must offer a choice from at least two cash or qualified benefits.
The Affordable Care Act Changed Cafeteria Plans
The Affordable Care Act changed the rules that apply to cafeteria plans in some important ways. The below-listed items describe the major revisions.
- Health Savings Accounts must be paired with High Deductible Health Plans.
- The employer plan must meet the Obamacare minimum essential coverage standard.
- The employer plan must be affordable; it must cost less than 9.5 percent of the annual family income.
Relief for Small Businesses
Firms with less than 50 full-time equivalent employees can use the qualified small employer health reimbursement arrangement. Often referred to as QSEHRA, employers can help employees with insurance and expenses.
The law became effective in 2017. This law extended a long time practice among firms that did not cover employees. They used employer funds to pay or reimburse employee health insurance costs and related health expenses.
The arrangements must meet the requirements of the ACA as amended by the 21st Century Cures Act or they will be taxable as income.
Disadvantages of Cafeteria Plans
The advantages of the original cafeteria plans for employers and employees were strong. The system did have a few potential weaknesses.
The flexibility was particularly important to small firms and small firms that did not offer coverage. The weak areas included the below-listed issues.
– Employer Risks Loss
Employer risk a dollar loss if employees leave before the year ends. The employee can use the entire annual designated amount at any time. If they leave the employer before the full deductions, then the employer has to pay the difference.
– Employees Risk Loss
Under the ACA rules, the employee’s unused funds did not roll over, and employees could lose any remaining balance at year end. The Treasury modified this rule to permit rollover and preservation of the employee’s assets.
– Annual Paperwork
Unlike general health insurance plans, employees must file a complete set of information each year on payroll deductions and other details for the cafeteria plan.
– Initial Imbalance
The employee must use pre-tax dollars to fund his or her sending account. After that, they must spend out-of-pocket to cover qualified expenses. After the deduction and the expenditures, they can get reimbursement. The employee must put money upfront to get reimbursed in the end.
Employee Income and Savings
The original cafeteria plan authorization provided employers and employees with significant savings on income. While most Americans had access to cafeteria plans, most did not take advantage of the benefits.
Employers that offered cafeteria plans, in effect, increased take-home pay without adding to costs.
- Income Taxes – By reducing taxable income, employees saved between 27 and 50 percent of each contributed dollar.
- FICA – The employer and employee saved on FICA contributions based on income.
- Increase Spendable Income – The net result of pretax deductions and owe taxes was an increase in spendable income for each employee participant.
Section 125 After Obamacare
The IRS and the federal Marketplace have provisions for cafeteria plans and for small employers that do not offer plans. The rules encourage participation by employers and employees in making health insurance coverage more accessible and affordable.
Comparison shopping is a helpful tool for consumers when selecting options from an employer-sponsored menu of health insurance benefits. Find out how much you can save by getting health insurance quotes in the box below!