Cafeteria plans provide health care savings
cafeteria plans are well worth a look if you want to protect your family's health
and well-being and save a few tax dollars while you're at it.
virtually unheard of 20 years ago, today some 20 percent of U.S. corporations
offer cafeteria benefits.
Put simply, cafeteria plans
are company benefit programs that allow employees to use pretax dollars to pay
certain out-of-pocket expenses. They are not health insurance plans.
plans -- also called 125 plans because they are defined in Section 125 of the
Internal Revenue Service Code -- are so-called because employees can pick and
choose from a menu of benefits custom designed by the employer. The choices most-often
offered are premium conversion and flexible spending arrangements.
The most common component of a cafeteria
plan is known as premium conversion, which permits employees to pay their cost
of employer-sponsored health insurance premiums with pretax dollars through payroll
deductions. In essence, you would save the same percentage of that sum that you
would have had to pay in federal income tax had it not been held aside. This is
somewhat diminished by the fact that because it's not considered taxable income,
it's also not included in your Social Security earnings and could affect your
Flexible spending arrangements
These widely used plans allow employees to pay for non-reimbursable health and
medical expenses and day care costs with pretaxed money.
An FSA allows an employee to set aside a pre-determined amount
of money through payroll withholdings to pay for certain out-of-pocket expenses.
The money is deducted from the employee's pay check before the
income is taxed, meaning it is exempt from federal, state and local, Social
Security and Medicare taxes.
Then, after you've spent money on things like doctor bills and
day-care, you can request reimbursement from the administrator of your account
and you'll get your money back, tax-free. Again, your savings equals the amount
you would have paid in taxes had the money not been deducted pretax. If you're
in the 25 percent tax bracket and had $3,000 held out for an FSA, you would
save 25 percent of $3,000, or $750.
There are two basic FSA plans you should be familiar with, say
The health care reimbursement account
Commonly called HCRA or Hecra, these allow deferrals from your gross income
before taxes into an account that you can use exclusively to pay for medical
expenses not covered by your insurance plan. Although the law does not limit
the amount you can designate for salary reduction, most employers do set a limit,
for example, $5,000.
Through your account, you can be reimbursed for your own, your
spouse's or children's health care expenses. Often these funds are used to pay
for expenses not normally covered by your traditional insurance, such as acupuncture,
chiropractors, birth control, dental work, orthodontics, vision care, infertility,
psychiatric care and even prescribed stop-smoking programs. And the IRS recently
OK'd using account funds for over-the-counter medications. HCRAs are popular
among employees with children, whose needs are often predictable for things
such as braces or glasses.
In fact, many people are using HCRAs to replace traditional insurance
plans for certain necessities like vision and dental appointments.
Also gaining in popularity is the use of the plans to pay for
more unconventional therapies that regular insurance won't look at, such as
The dependent care reimbursement account
Also known as DCRA or Decra, it allows up to $5,000 a year tax-free for care
for children or other dependents. Reimbursement is simple: Each time you pay
your child-care provider, you send the receipt to your employer, who cuts a reimbursement
check from your DCRA plan.
With both a HCRA and a DCRA, you reduce your current income taxes
each paycheck, much like you do with a 401(k) salary deferral. It's like paying
yourself back each time you pay qualifying expenses. If 25 cents is taxed out
of each dollar you earn, for example, you only have 75 cents left to pay uncovered
medical or child-care expenses.
Use it or lose it
But there's some potentially bad news as well -- news that is the biggest single
drawback to flex plans and a deal-killer to many employees offered the tax-cutting
plan: If you don't use it, you lose it.
At the beginning of each year, you must estimate the amount you're
going to spend on these items to determine how much is withheld from taxes each
payday. If you overestimate the amount, you forfeit whatever is left over. In
May, the Internal Revenue Service loosened the use-it-or-lose-it constraint
by announcing that it will allow spending plan participants to make claims against
their accounts for up to two months and 15 days after the end of their benefit
year. Any money left in the account after that is lost.
"That's probably the single misconception about flex plans
-- that you can withdraw your money at any time, that it will always be there,"
says Kathleen Stoll, director of policies for Families USA, a nonprofit organization
that advises consumers on health-related issues. "It's not a piggy bank.
People should be aware that there is a risk involved before they sign up. Flex
plans can be confusing to many people. That's probably why so few people are
James Meyer, vice president of the Washington, D.C.-based Economic
and Social Research Institute, agrees: "The use-it-or-lose-it' flex or
cafeteria plan is not proving popular simply for that reason. People do not
want to take the chance of losing their hard-earned money."
Studies by benefits specialists regularly show that employees
typically forfeit more than $100 each year in flexible medical accounts. Worse
yet, the money forfeited usually goes to the employer, something that particularly
annoys many employees. Businesses generally use the leftover money to help defray
administrative costs of the program. In some instances, employers allow workers
to designate a charity to which the unused funds are sent.
A pre-approved benefits 'loan'
The flipside to the use-it-or-lose-it gripe, however, is that you can get to
the money even before it's in your account, and if you spend more than you've
set aside and leave the company, you don't have to pay it back.
Say you elected to put $2,400 in your medical spending account,
with $200 a month coming from each of your 12 paychecks that year. In early
March, your son fell off his bike and, in addition to breaking his arm, all
his expensive orthodontia had to be redone. When all the damage was added up,
you faced $950 in deductibles not covered by your health insurance.
Although you only had $400 in your account when the accident occurred,
federal guidelines allow you to submit your out-of-pocket expenses immediately
for repayment. This way, you get cash today against the total amount you pledged
to pay into the account tomorrow.
Other FSA drawbacks
- With a DCRA, you must provide the tax ID number or Social Security
number of your child-care provider. This presents a problem for anyone paying
caregivers under the table and is one reason why so few employees choose to
participate in these plans.
- Also in a DCRA, you're not allowed to use the standard child-care
credit on your tax return. This could pose a problem for a lower-income worker,
who might be better off sticking with the credit. Most employers provide a
worksheet in the initial enrollment kit to help you figure out which option
works best for you.
- With either reimbursement account it's difficult to change
your level of participation. Unless there is a major change in your life --
marriage, divorce, birth of a child, reduction in work hours, or job loss
or change by your spouse -- you're stuck with putting in what you chose during
the enrollment period. Similarly, only a life-change event will get you into
a flexible spending account plan if you miss the sign-up deadline. For most
companies, the deadline is Dec. 31. But some operate on a fiscal, rather than
calendar year, so check with your benefits manager for your deadline.
- Then there's what many call "the $5,000 joke." The
IRS limits the annual contribution for dependent care accounts to $5,000.
This is a family limit, meaning that even if both parents have access to flexible
care accounts, their combined annual contributions cannot exceed $5,000. Linda
Wurzelbacher of BASIC, an employee benefits administration firm, says, "Employees
are always telling us $5,000 is a joke," she said. "It's not an
amount that has kept up with the times. Anybody with kids will tell you that
they easily exceed this amount in day care in a year."
Bill Burt is a freelance writer based in
-- Updated: May 23, 2005