Section 125 Cafeteria Plans: What Employers Need to Know

Whether you knew it or not, your organization likely has a Section 125 cafeteria plan. Even though cafeteria plans are quite common, ERISA compliance can be an oversight for many employers. But the consequences of noncompliance can be costly.

So, here’s what employers need to know about Section 125 plans, including how to keep your organization compliant.

What is a Section 125 Cafeteria Plan?

A cafeteria plan gives employees the option to set aside part of their compensation as pre-tax contributions toward health insurance and other benefits. Cafeteria plans are often called Section 125 plans—a reference to the part of the Internal Revenue Code that outlines how such plans may operate.

Section 125 cafeteria plans offer tax savings for both employees and employers. An employee’s taxable income—or gross pay—is reduced, and an employer’s contributions to benefits are not taxed.

Most cafeteria plans are premium-only plans (POPs) which means that pre-tax contributions go toward policy premiums. Still, there are other types of Section 125 arrangements, including simple cafeteria plans, full flex plans, and flexible spending accounts (FSAs).

Cafeteria plans can cover group health, dental, vision, and term life insurance up to $50,000 as well as dependent care FSAs, disability insurance, and adoption assistance. However, according to the IRS, a cafeteria plan cannot include Archer MSAs, athletic facilities, educational assistance, meals, or commuter benefits—though commuter benefits can complement a cafeteria plan.

As mentioned, cafeteria plans have become so ubiquitous that this arrangement may sound pretty familiar to you even if you didn’t know a Section 125 plan by name.

But what you may not know could hurt your organization!

What Employers Need to Know about Section 125 Cafeteria Plan Compliance

Most private-sector employee benefits plans, including cafeteria plans, are governed by the Employee Retirement Income Security Act (ERISA). ERISA compliance is enforced by the Department of Labor through the Employee Benefits Security Administration (EBSA).

ERISA covers any retirement plan that provides either retirement income in the future or the opportunity for employees to contribute current wages to retirement. Major plans covered under ERISA also include:

• Major medical plans
• Dental
• Vision
• Prescription benefits
• FSAs
• HSAs
• Specific EAPs
• Wellness programs
• Cancer policies

Plans that do not fall under ERISA primarily include pensions or other plans provided by the United States government, state or local governments, and churches.

ERISA applies to employers of all sizes who offer qualified plans. Employers who administer ERISA-qualified plans are called “fiduciaries” and bear responsibility for compliance. In other words, even though fiduciaries depend on insurance carriers and plan administrators to design, communicate, and manage benefits, the employer is responsible for plan compliance. 

It’s highly recommended that small to midsize employers read the DOL’s guides to fiduciary responsibility: “Meeting Your Fiduciary Responsibilities” and “Understanding Your Fiduciary Responsibilities Under a Group Health Plan.”

Whenever a misunderstanding about responsibility results in noncompliance, the issue is often related to plan documents. For example, according to ERISA, plan documents should be updated regularly—whether or not changes have been made to the plan. Correcting that oversight should be easy enough.

It’s more difficult, however, to ensure your plan meets SPD and discrimination testing requirements.

How to Keep Your Section 125 Cafeteria Plan Compliant

By now, you’ve probably intuited that ERISA requires fiduciaries to maintain written plan documents. After all, how could EBSA regulate ERISA-qualified cafeteria plans that haven’t been written down in the first place?

Every plan must have a master plan document and a Summary Plan Description. These documents can be lumped together into one or stand alone, but fiduciaries must have both. This applies regardless of whether you administer a Section 125 plan or not.

A master plan document is a governing document, often written in dense legal language, that describes all the details of the cafeteria plan—including, among other things, information about:

• Included benefits
• Eligibility
• How contributions are made
• Contribution limits
• Plan sponsor and administrator information
• Procedures for highly compensated employees

Most insurance carriers and third-party administrators (TPAs) provide policy and coverage information to comply with applicable state regulations, but that documentation may lack all the information necessary to meet federal ERISA requirements as well. 

Remember, as fiduciaries under ERISA, employers—rather than insurers—bear the responsibility for compliance.

A Summary Plan Description (SPD) is similar to the master plan document—but with the requirement that it must be written plainly. More specifically, the DOL clarifies that an SPD is the “primary vehicle for informing participants and beneficiaries about their plan” and “must be written for an average participant and be sufficiently comprehensive to apprise covered persons of their benefits, rights, and obligations under the plan.”

To comply, a written SPD must include:

• The plan name, address, and contact information
• The plan benefits and how to file a claim for them
• The duties of the plan and/or employee
• The plan’s claims procedure
• The basic ERISA rights and responsibilities of plan participants
• Information about premiums, deductibles, and copayments
• Information about who’s in-network and how to use providers
• Precertification procedures
• Plan procedures for Qualified Medical Child Support Orders
• Notices and descriptions of certain HIPAA rights and other health coverage laws

You’ll notice much of this information may already be covered in the master plan document, but again, it is the fiduciary’s responsibility to ensure that the required information is included.

Additionally, according to the DOL, employers are required to provide participants with an SPD within 90 days of the start of coverage and within 30 days of a request.

As mentioned, the master plan document and the SPD can be lumped together—but they are not interchangeable. An ERISA wrap document can supplement the insurance policy, coverage certificate, or plan booklet provided by carriers, filling the gaps to comply with federal regulations.

Unlike SPDs, ERISA wrap documents are not required, but they can simplify SPD compliance. In fact, “wrap document” is not a formal term used by the federal government. But that doesn’t mean employers should overlook the benefits of having an ERISA wrap document.

A wrap document can also be used to consolidate several employer-sponsored benefit plans into a single “umbrella” plan, which could reduce the costs and administrative burden of filing and distributing multiple annual reports, such as Form 5500.

Large employers often have the time, money, and expertise to prepare SPDs and other custom documents for each plan they sponsor, but most small businesses do not have the resources to prepare custom documents for each plan or participant on demand and stay up-to-date with changing regulations at the same time.

Fiduciaries must also comply with the Section 125 discrimination testing requirement, ensuring the plan does not:

1. discriminate in favor of highly compensated employees regarding eligibility.
2. discriminate in favor of highly compensated employees regarding benefits and contributions.
3. provide key employees with pre-tax benefits that exceed 25% of those provided for all employees under the plan.

According to SHRM, a “highly compensated individual” is someone making $130,000 or more per year and a “key employee” is someone making $185,000 or more per year—among other criteria. If a cafeteria plan fails a discrimination test, it affects the highly compensated or key employees—who could lose the tax advantages of the plan—but not other plan participants.

Compliance can be overwhelming. However, if you need help with your organization’s Section 125 plan—especially creating compliant benefits documents—reach out to Alpine, a qualified third-party administrator and BerniePortal’s sister company.

Additional Resources

You can stay informed, educated, and up-to-date with important HR topics using BerniePortal’s comprehensive resources:

• BerniePortal Blog—a one-stop-shop for HR industry news
• HR Glossary—featuring the most common HR terms, acronyms, and compliance
• HR Guides—essential pillars, covering an extensive list of comprehensive HR topics
• BernieU—free online HR courses, approved for SHRM and HRCI recertification credit
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