What is a cafeteria plan?
A cafeteria plan allows employees to contribute a certain amount of their gross income to one or more accounts pre-tax. The most common accounts are used to save for medical costs not covered by insurance.
Sometimes referred to as a “Section 125 plan” (in reference to the IRS section that allows such plans), a cafeteria plan is designed to help you put away money in a manner that allows you to save on taxes. Say you make $50,000 per year and contribute $3,000 to a Section 125 plan. Your gross taxable income automatically drops by $3,000 to $47,000. If you are single, $47,000 puts you in the 25 percent tax bracket, meaning you save $750 by not having to pay taxes on the amount contributed to your plan.
Depending on your tax bracket, you can save from 10 percent to 40 percent on city, state and federal income taxes. You also save on Social Security and Medicare taxes. Employers offer these programs because they save money, too, by paying less toward your Social Security and Medicare taxes.
Cafeteria plan examples
- Premium only plan (POP). A POP allows for group insurance premiums to be paid on a pre-tax basis. These insurances include health, dental, vision, prescription, group term life (up to $50,000), hospital indemnity, accident, Medicare supplement, cancer and disability.
- Flexible spending account (FSA). An FSA can be used to pay deductibles and co-payments, as well as pay for prescriptions, certain medical and dental expenses for a spouse and dependents, and for medical equipment, such as blood-sugar test kits.
- Health savings account (HSA). An HSA is designed to help those with high deductibles set aside money to pay their medical expenses. An HSA can be used to pay for medical, dental and vision care; prescription drugs; health insurance if you are getting unemployment; COBRA continuation coverage; Medicare part A or part B premiums; and premiums for qualified long-term care insurance.
Looking for other ways to save on health care? These 10 tips can help.