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What's on the (benefits) menu?

A cafeteria plan is just what the name implies: a benefits program that lets you take just what you like.

So if you want to go light on the retirement benefits and get a more complete health plan while a co-worker socks away big bucks for child care, feel free.

"There are a couple of different varieties," says Bonnie Whyte, executive director of the Employers Council on Flexible Compensation, a membership group open to companies that offer cafeteria and other similar plans. "[Cafeteria plans allow] paying for benefits on a pretax basis, which is very cost-effective for employees and employers."

Just to make it more confusing, a cafeteria plan has several aliases, among them flex plan and -- in honor of the IRS code section where it's defined -- a 125 plan.

"A cafeteria plan is a delivery system for offering employee benefits which employees pay for before paying Social Security and federal and, usually, state income taxes," says Whyte.

Some of the elements it might offer: accident and health insurance, group term life insurance, dependent-care assistance, elective contributions to a 401(k), elective vacation days and flexible spending accounts for health care or dependent care.

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Once you enroll in the plan, you have to stay with your choices for a year, unless you have a major life event like a marriage, birth, death, divorce, move, etc., "that causes some change in your eligibility for coverage," says Judy Bauserman, a senior consultant for Mercer Human Resource Consulting.

"And the election you make has to be consistent with that event," she says. For instance, if you get a divorce you can delete your ex from the plan and adjust your coverage to complement the new family income.

Depending on the type of plan your company has designed, you may have a lot of choices or very few. Here's a rundown on three basic formats:

Premium only plan: This is the most basic arrangement. It lets you pay for your contributions to health and insurance premiums in pretax money through payroll deductions. Whatever percentage you pay in income tax -- that's essentially the "discount" you're reaping.

"This is something that no one should sneeze at," says Whyte.

The downside: The company is making you pay at least part of your premiums. Since it comes from pretax dollars -- lowering your taxable income -- it also may reduce your Social Security when you retire.

Check into it ahead of time, especially if you're paying a large premium and "you're very close to retirement age," says Lenny Sanicola, project manager for WorldatWork, a global nonprofit association for compensation and benefits professionals.

But Doug Griffith, president of BusinessPlans Inc., parent company of www.mycafeteriaplan.com, a third-party administrator for 125 cafeteria plans, believes the impact is "generally minimal."

"Losing 15 cents on the dollar to Social Security," he says, isn't bad if you're "saving 25 cents and put that in a tax-deferred plan.

"Which will benefit you more?" Griffith says.

Flexible spending arrangement (or flexible spending account): This item has become very hot on a lot of cafeteria plan menus. You put pretax dollars through regular payroll deductions into an account for health care or dependent care. Then you tap that account to pay for any qualified, unreimbursed expenses you have during the year. Again, by using pretax money, you are getting a "discount" on those services equal to whatever percentage you pay in annual income tax.

The downside: You budget annually, and if you don't use the money, you lose it. If you quit or get laid off, you have until the end of the plan year -- plus 90 days -- to file for any expenses incurred while you were an employee, says Sanicola. In May 2005, the Internal Revenue Service loosened the use-it-or-lose-it constraint by allowing plan participants to make claims against their accounts, for up to two months and 15 days after the end of their benefit year. Check with your company's plan to see if it offers this extension. Any money left in the account after that is lost but if you plan conservatively and carefully, you can avoid this loss.

The key to getting the most from a flexible spending account is to predict just how much money you'll need for child-care or health care -- one year in advance.

"It's hard to anticipate," says Sanicola. "We advise them to be conservative."

Flexible spending accounts come in two basic types:

dependent-care flexible spending account: With a dependent-care account, you are allowed to bank up to $5,000 a year (or $2,500 if you're married and filing single) to pay for daycare for children, the handicapped and the elderly.

Two caveats: If you use a dependent-care account to pay for child care, you have to be very careful about applying for the child-care tax credit. Whatever money you pull from the account to pay child-care bills will not count toward the tax credit, says Bryan Zoran, research associate with the International Foundation of Employee Benefit Plans, an educational association serving the benefits industry.

Griffith agrees. "You just have to be careful you're not double-dipping," he says. Best bet: Talk to a tax adviser to keep you out of trouble.

And you also want to look at which method gives your family the most bang for its buck. It depends on the number of children you have and your income.

"Frequently, the child-care credit is a best option," says Whyte.

When you set up a dependent-care account to use for elder care, the rules on what -- and who -- would qualify are tricky. "The rule is that they have to be a dependent," says David Turner, marketing and sales director for BusinessPlans. As far as what kind of care could qualify, "that's a gray area," he says.

Again, before you choose this option, a call to your tax adviser will keep you out of trouble.

Health-care flexible spending account: With a health-care account, your company will set a limit that you're allowed to bank each year. "The majority of our companies are setting it around $2,500," says Turner. For smaller companies trying to reduce their risk, it's more likely to be $1,000 to $1,500, he says.

Sanicola is seeing company limits around $2,500 to $3,000.

The account covers qualified, unreimbursed medical and dental expenses. While it won't cover cosmetic procedures like Botox or teeth whitening, it's especially popular for big ticket items such as orthodontics and laser eye surgery, says Turner, who finds that companies are using medical spending accounts as an alternative to vision or dental coverage.

Doctor's visit co-pays and prescriptions are "by far the most frequent uses," says Whyte.

The key is to plan what sorts of medical or dental procedures your family is likely to need and budget accordingly. And the accounts are good for qualified unreimbursed health-care expenses for any dependent. So if your company picks up only your health insurance but your spouse has an unreimbursed co-pay from another plan, you can dip into the health-care flexible spending account to pay it.

With health care, it's difficult to estimate your needs ahead of time. Sit down and look at your medical bills from last year. Find out what kinds of thing are covered -- and what isn't. Ask the pharmacist to give you a 12-month total of what you're spending on prescriptions. And, if you're planning a big-ticket item like laser eye surgery, iron out all the details before you make your choices.

The downside: Any expenses that are covered by the account can't be itemized on your tax return at the end of the year. But since you need to accumulate 7.5 percent of your adjusted gross income in unreimbursed medical bills before you'd qualify for the deduction, that wouldn't affect most families, says Bauserman.

Cafeteria plans: The next level of coverage is a full-blown cafeteria plan. Basically, the employee is given a certain amount of money or credits to put toward an array of benefits.

The plans can vary widely. Some employers contribute money to the plan, others don't. Some companies let employees "cash out" or keep any dollars not spent on benefits -- others won't. And some plans provide a minimum or safety net of coverage, above which the employee can make their own decisions. Others do not.

"Most employers provide a core level of benefits, so if an employee makes poor choices they will have minimums on [things like] disability and life," says Sanicola.

Griffith says that the companies he sees are not doing that. But, he points out, most smaller companies are concentrating on the meat-and-potatoes benefits of health insurance and flexible spending accounts, so it's not like their employees could trade all their insurance for vacation time in the sun.

"For any employee, when they are offered any kind of benefits, they have to figure out a) what they need and b) what they can afford," says Whyte. "A single 25-year-old doesn't need a lot of life insurance. Someone married with kids does."

On the other hand: "Everyone needs health insurance," says Whyte. "So this needs to be their first priority."

Where it gets tricky, she says, is when two spouses try to pick and choose the best elements from each of their company benefits packages. "You want to use them so you get the greatest amount for the least amount of money," says Whyte.

"The whole concept is to give employees more choice in what's important," says Sanicola, "and the ability to tailor it to meet their needs."

Dana Dratch is a freelance writer based in Atlanta.

-- Posted: May 20, 2004

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