Advantages and Disadvantages of a Section 125 Cafeteria Plan

The Section 125 Cafeteria Plan is regulated by the Internal Revenue Service. It is an employee benefit that allows the employer to deduct pre-tax employee contributions to pay for health, dental and vision premiums. This plan is a win- win scenario for the employee and the employer. Because it reduces the amount of federal, state and local taxes that the employee will owe and for the employer it reduces the payroll tax liability. It also affects the employee and the employer in other ways.

Advantages
The advantages an employee enjoys under the Section 125 Cafeteria Plan works in the following way. From the employee's gross income for the month, a specific amount of dollars may be deducted by the employer to pay for health premiums. This amount is deducted before any with holding tax is taken. The taxable income for the month is therefore reduced. Example: An employee pretax monthly income is $3000.00. Health premium deducted pretax by the employer to be placed in the Section 125 Cafeteria Plan is $500.00. The employee's taxable income is now reduced to $2500.00. The employee saves on income taxes, takes home a bigger pay check because their gross income is now in a lower tax bracket. The employer also benefits, because a reduction in the employee's gross pay also reduces the amount the employer pays for that employee's social security, Medicaid and worker's compensation as well as unemployment if necessary.

Disadvantages
There are long term disadvantages to an employee who participates in a Section 125 Cafeteria Plan. The short term benefits to an employee of participating in the Section 125 Cafeteria Plan results in a reduction in gross monthly salary and a lower tax bracket payments. This caused a reduction in the employee's gross income and in social security and tax payments of the employee and the employer to the IRS. These short term benefits will affect the employee's unemployment and worker's compensation benefit payments and their future social security payments when they retire since they are calculated based on an employee's gross income.

According to the Internal Revenue Service, cafeteria plan can provide health insurance benefits to employees, their spouses and their dependents. A domestic partner and dependents may benefit from an employee's choice of family medical insurance coverage or coverage under a dependent care assistance program, but they cannot be participants in the cafeteria plan since they are not employees.