What is a cafeteria plan in health insurance?


Just as the name suggests, this kind of health insurance plan is like a cafeteria, but only for health insurance benefits. Just like in a cafeteria, where you get to pick and choose the benefits you want to have and feel you need. Using a cafeteria plan, a small business will be able to offer a wider variety of benefits that the business can't otherwise afford.

They are also known as Section 125 plans, since cafeteria plans are defined in Section 125 of the US Internal Revenue Code. Based on the definition, one can use cafeteria plans to decrease one's taxable income, resulting in tax savings. With a cafeteria plan, a person can go to a lower tax bracket. Even if the employer will be the one paying for the benefits, it may be cheaper to do so because of the tax savings that he will get.

What happens is that the employee is given a set amount for him to spend on the benefits of his choice.

The cafeteria plan can provide not just health insurance but also other products as well - including dental, vision, accident insurance, disability insurance and group term life insurance.

The money being used is pre-tax dollars that the employee has approved to be redirected from his salary. This means that the money to pay for a cafeteria plan is taken out of the employee's paycheck before his income is charged for taxes. This means that the employee will pay fewer taxes for unemployment and social security, as well as for Medicare and federal income tax computations.

The contribution to the cafeteria plan should be equal to:

  • An amount that is more than either:
    • Two times of a qualified employee's salary reduction contributions, or
    • 6% of what the employee stands to get during the plan year
    • whichever is smaller.
  • Not less than 2% of the compensation of the employee during the plan year

An employer is eligible to offer a simple cafeteria plan if:

  • All employees that have served more than 1,000 hours are eligible to join
  • All employees have equal rights to choose under the plan
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